U.S. GOVERNMENT PRINTING OFFICE

55–945 CC WASHINGTON : 1999

OVERSIGHT OF PENSION ISSUES

HEARING

BEFORE THE

SUBCOMMITTEE ON OVERSIGHT

OF THE

COMMITTEE ON WAYS AND MEANS

HOUSE OF REPRESENTATIVES

ONE HUNDRED FIFTH CONGRESS

SECOND SESSION

MARCH 10, 1998

Serial 105–69

Printed for the use of the Committee on Ways and Means

(
ii

COMMITTEE ON WAYS AND MEANS

BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois

BILL THOMAS, California

E. CLAY SHAW, JR., Florida

NANCY L. JOHNSON, Connecticut

JIM BUNNING, Kentucky

AMO HOUGHTON, New York

WALLY HERGER, California

JIM MCCRERY, Louisiana

DAVE CAMP, Michigan

JIM RAMSTAD, Minnesota

JIM NUSSLE, Iowa

SAM JOHNSON, Texas

JENNIFER DUNN, Washington

MAC COLLINS, Georgia

ROB PORTMAN, Ohio

PHILIP S. ENGLISH, Pennsylvania

JOHN ENSIGN, Nevada

JON CHRISTENSEN, Nebraska

WES WATKINS, Oklahoma

J.D. HAYWORTH, Arizona

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

CHARLES B. RANGEL, New York

FORTNEY PETE STARK, California

ROBERT T. MATSUI, California

BARBARA B. KENNELLY, Connecticut

WILLIAM J. COYNE, Pennsylvania

SANDER M. LEVIN, Michigan

BENJAMIN L. CARDIN, Maryland

JIM MCDERMOTT, Washington

GERALD D. KLECZKA, Wisconsin

JOHN LEWIS, Georgia

RICHARD E. NEAL, Massachusetts

MICHAEL R. MCNULTY, New York

WILLIAM J. JEFFERSON, Louisiana

JOHN S. TANNER, Tennessee

XAVIER BECERRA, California

KAREN L. THURMAN, Florida

A.L. SINGLETON, Chief of Staff

JANICE MAYS, Minority Chief Counsel

SUBCOMMITTEE ON OVERSIGHT

NANCY L. JOHNSON, Connecticut, Chairman

ROB PORTMAN, Ohio

JIM RAMSTAD, Minnesota

JENNIFER DUNN, Washington

PHILIP S. ENGLISH, Pennsylvania

WES WATKINS, Oklahoma

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

WILLIAM J. COYNE, Pennsylvania

GERALD D. KLECZKA, Wisconsin

MICHAEL R. MCNULTY, New York

JOHN S. TANNER, Tennessee

KAREN L. THURMAN, Florida

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records

of the Committee on Ways and Means are also published in electronic form. The printed

hearing record remains the official version. Because electronic submissions are used to

prepare both printed and electronic versions of the hearing record, the process of converting

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process

is further refined.
iii

C O N T E N T S

Page

Advisories announcing the hearing ........................................................................ 2

WITNESSES

U.S. General Accounting Office, William J. Scanlon, Director, Health

Financing and Systems Issues, Health, Education, and Human Services

Division ................................................................................................................. 89

Pension Benefit Guaranty Corporation, David M. Strauss, Executive Director 22

American Council of Life Insurance, Ron E. Merolli ............................................ 42

American Society of Pension Actuaries, Michael Callahan .................................. 66

Business and Professional Women/USA, Gail Shaffer ......................................... 61

Greg Fradette Agency, Inc., Greg Fradette, Sr ..................................................... 75

Institute of Electrical and Electronics Engineers, Inc.-United States of

America, James V. Leonard ................................................................................ 54

National Life Insurance Co., Ron E. Merolli ......................................................... 42

Pension Rights Center, Gregory Moore ................................................................. 47

PenTec, Inc., Michael Callahan .............................................................................. 66

SUBMISSIONS FOR THE RECORD

Blunt, Hon. Roy, a Representative in Congress from the State of Missouri,

statement .............................................................................................................. 102

Neal, Hon. Richard E., a Representative in Congress from the State of

Massachusetts, statement ................................................................................... 28

Yakoboski, Paul J., Employee Benefit Research Institute, statement ................ 105
(1)

OVERSIGHT OF PENSION ISSUES

TUESDAY, MARCH 10, 1998

HOUSE OF REPRESENTATIVES,

COMMITTEE ON WAYS AND MEANS,

SUBCOMMITTEE ON OVERSIGHT,

Washington, DC.

The Subcommittee met, pursuant to notice, at 3:03 p.m., in room

1100, Longworth House Office Building, Hon. Nancy L. Johnson

(Chairwoman of the Subcommittee) presiding.

[The advisories announcing the hearing follow:]
2

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

SUBCOMMITTEE ON OVERSIGHT

FOR IMMEDIATE RELEASE CONTACT: (202) 225–7601

March 3, 1998

No. OV–13

Johnson Announces Hearing on

Oversight of Pension Issues

Congresswoman Nancy L. Johnson (R–CT), Chairman, Subcommittee on Oversight of the Committee on Ways and Means, today announced that the Subcommittee will hold a hearing on oversight of various pension issues. The hearing will take

place on Tuesday, March 10, 1998, in the main Committee hearing room, 1100

Longworth House Office Building, beginning at 2:00 p.m. In view of the limited time

available to hear witnesses, oral testimony at this hearing will be from invited witnesses only. Witnesses will include officials from the Pension Benefit Guaranty Corporation (PBGC), experts in the area of pension plan coverage, employers and other

business representatives, and association representatives. However, any individual

or organization not scheduled for an oral appearance may submit a written statement for consideration by the Committee and for inclusion in the printed record of

the hearing.

BACKGROUND:

PBGC insures the retirement incomes of more than 42 million American workers—one of every three workers—in about 50,000 defined benefit pension plans. A

defined benefit plan provides a specified benefit at retirement, often based on a combination of salary and years of service. PBGC is financed through premiums collected from plan sponsors, returns on investments, and recoveries from employers

responsible for underfunded terminated plans. PBGC currently pays monthly retirement benefits to about 200,000 retirees in over 2,348 terminated plans. The Ways

and Means Committee considers legislation concerning PBGC premiums and also

exercises jurisdiction over the tax treatment of pension plans.

Half of all American workers, over 50 million people, are without pension coverage. According to the U.S. General Accounting Office, 87 percent of workers employed by small businesses with fewer than 20 employees have no retirement coverage, and 62 percent of workers in small businesses with between 20 and 200 employees have no retirement plan coverage, while 72 percent of workers in firms with

over 500 employees have some form of retirement plan coverage.

Coverage is most limited in the sector of the economy that provides most of the

new jobs in today’s workforce: small business. According to the Small Business Administration, 75 percent of the 2.5 million new jobs created in 1995 were created

by small businesses. While many small businesses sponsor defined contribution

plans, according to the U.S. Department of Labor, between 1987 and 1993, the number of small businesses with defined benefit plans dropped from 108,221 to 41,780—

a 60 percent decline in seven years.

In announcing the hearing, Chairman Johnson stated: ‘‘It is alarming that half

of all American workers are without pension coverage today, and that only 20 percent of workers in small businesses have pension coverage. We know how difficult

it is for seniors to live on Social Security benefits alone. As the baby boomers approach their retirement years, the need to broaden pension coverage is greater than
3

ever. We need to determine whether the complexity of pension law is coming between workers and the coverage they need.’’

FOCUS OF THE HEARING:

The hearing will focus on the current availability of pension plans to American

workers, incentives for, and obstacles to, expanded pension coverage, the financial

status and administration of Federally-insured pension plans monitored by PBGC,

and related issues involving retiree health benefits.

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

Any person or organization wishing to submit a written statement for the printed

record of the hearing should submit at least six (6) single-space legal-size copies of

their statement, along with an IBM compatible 3.5-inch diskette in ASCII DOS Text

or WordPerfect 5.1 format only, with their name, address, and hearing date noted

on a label, by the close of business, Tuesday, March 24, 1998, to A.L. Singleton,

Chief of Staff, Committee on Ways and Means, U.S. House of Representatives, 1102

Longworth House Office Building, Washington, D.C. 20515. If those filing written

statements wish to have their statements distributed to the press and interested

public at the hearing, they may deliver 200 additional copies for this purpose to the

Subcommittee on Oversight office, room 1136 Longworth House Office Building, at

least one hour before the hearing begins.

FORMATTING REQUIREMENTS:

Each statement presented for printing to the Committee by a witness, any written statement

or exhibit submitted for the printed record or any written comments in response to a request

for written comments must conform to the guidelines listed below. Any statement or exhibit not

in compliance with these guidelines will not be printed, but will be maintained in the Committee

files for review and use by the Committee.

1. All statements and any accompanying exhibits for printing must be typed in single space

on legal-size paper and may not exceed a total of 10 pages including attachments. At the same

time written statements are submitted to the Committee, witnesses are now requested to submit

their statements on an IBM compatible 3.5-inch diskette in ASCII DOS Text or WordPerfect

5.1 format. Witnesses are advised that the Committee will rely on electronic submissions for

printing the official hearing record.

2. Copies of whole documents submitted as exhibit material will not be accepted for printing.

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material

not meeting these specifications will be maintained in the Committee files for review and use

by the Committee.

3. A witness appearing at a public hearing, or submitting a statement for the record of a public hearing, or submitting written comments in response to a published request for comments

by the Committee, must include on his statement or submission a list of all clients, persons,

or organizations on whose behalf the witness appears.

4. A supplemental sheet must accompany each statement listing the name, full address, a

telephone number where the witness or the designated representative may be reached and a

topical outline or summary of the comments and recommendations in the full statement. This

supplemental sheet will not be included in the printed record. The above restrictions and limitations apply only to material being submitted for printing. Statements and exhibits or supplementary material submitted solely for distribution to the Members, the press and the public

during the course of a public hearing may be submitted in other forms.

Note: All Committee advisories and news releases are available on the World

Wide Web at ‘HTTP://WWW.HOUSE.GOV/WAYSlMEANS/’.

The Committee seeks to make its facilities accessible to persons with disabilities.

If you are in need of special accommodations, please call 202–225–1721 or 202–226–

3411 TTD/TTY in advance of the event (four business days notice is requested).

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above.

f
4

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

SUBCOMMITTEE ON OVERSIGHT

FOR IMMEDIATE RELEASE CONTACT: (202) 225–7601

March 9, 1998

No. OV–13-Revised

Time Change for Subcommittee Hearing on

Tuesday, March 10, 1998,

on Oversight of Pension Issues

Congresswoman Nancy L. Johnson (R–CT), Chairman of the Subcommittee on

Oversight, Committee on Ways and Means, today announced that the Subcommittee

hearing on oversight of pension issues, scheduled for Tuesday, March 10, 1998, at

2:00 p.m., in the main Committee hearing room, 1100 Longworth House Office

Building, will begin instead at 3:00 p.m.

All other details for the hearing remain the same. (See Subcommittee press release No. OV–13, dated March 3, 1998.)

Mr. P

Mrs. Johnson is taking care of some business, and she’ll be joinORTMAN [presiding]. The Subommittee will be in order.

f

ing us shortly.

Today, we are here to examine the issues surrounding our current pension system and the obstacles to coverage for a great number of workers. Because health care demands a significant portion

of the incomes of many seniors, retired health care is also an important retirement income security issue, we also will be delving

into that somewhat today.

All of us want to ensure that individuals are adequately prepared

for retirement. Yet the complexity of Federal laws and regulations

sometimes make that more, not less, difficult. This is especially

troublesome, as many of you know in the small business sector,

where currently 87 percent of workers employed by companies with

20 or fewer employees have no pension coverage whatsoever.

The SIMPLE, Savings Incentive Match Plan for Employees, defined contribution plan for small businesses that Senator Dole and

I authored a couple of years ago, has been quite successful. But we

need to do a lot more, and I am very pleased that Chairwoman

Johnson and this Subcommittee are taking a careful look at this.

Chairwoman Johnson has placed particular emphasis on that issue,

and I congratulate her on the leadership she has shown in introducing a defined benefit plan for small business, SIMPLE being the

defined contribution plan; Mrs. Johnson’s being a defined benefit

plan called the SAFE, Secure Assets for Employees Plan Act of

1997, plan.
5

They say imitation is the sincerest form of flattery, so Mrs. Johnson should feel especially proud and flattered that the administration has also sent forward its small business defined benefit plan,

the SMART, Secure Money Annuity or Retirement Trusts, plan. So

we have SIMPLE, SAFE, and SMART. We will hear more about

those later today.

We’re especially focused on small business today, as I said, but

we also must continue our efforts to simplify the pension area for

all businesses. My colleague Ben Cardin, with whom I worked to

get pension simplifications in both the 1996 and 1997 tax packages,

and I are working on additional provisions. The current patchwork

of laws and regulations, we think works against a coherent national retirement income policy, and we are putting together a second simplification package which we hope to introduce within the

next month.

I want to urge this Subcommittee and the Full Committee to continue to look at retirement issues in a broad-based way so that employers are not burdened by the complex regulations that so often

negate the positive intentions of the laws we pass in this area.

I very much look forward to today’s witnesses. And, again, Mrs.

Johnson will be joining us at about 4 p.m. I would now like to yield

to Mr. Coyne for a statement.

Mr. COYNE. Thank you, Mr. Chairman.

As you know today’s hearing will focus on one of the most important issues facing American workers and their families: Pension

coverage. Retirement income is an issue of concern to all Americans, whether they are currently retired, planning for retirement,

or worrying about the economic stability of their retired parents

and grandparents.

The PBGC, Pension Benefit Guaranty Corporation, ensures the

retirement incomes of more than 42 million workers. The PBGC

now shows a surplus for the first time in 22 years of its history.

At the same time, about two thirds of our single employer plans

are fully funded, with assets of over $1 trillion. This is great news

for all workers who are currently covered by private pensions. It

means that they can count on their pensions being there when they

are ready to retire. But at the same time, more than half of all

American workers, about 50 million people, do not have any retirement coverage at all. When they retire, they will have to depend

on Social Security payments, their personal savings, and the generosity of friends and families.

It is within the Subcommittee’s oversight responsibilities to ask

why this is and what can we do to expand coverage. In Pittsburgh,

the city that I represent, 43 percent of my retired constituents do

not have private pensions. A Social Security check, which averages

less than $750 a month in Pennsylvania, is all most of them have

to pay their bills.

One of their greatest fears is that they will need expensive

health care or prescription drugs, because many employers are

dropping retiree health coverage, leaving their former workers completely dependent on Medicare and their personal savings.

The stories in my district are similar to those of Americans

across the country who do not have pensions. Most of them work

for small businesses. Many of them work for wages that are so low
6

that they cannot contribute to a retirement plan, which often results in them not having retirement plans at all. Some of them

never worked for any one employer long enough to be vested in the

retirement plan. Many of them are widows living alone. Threefourths of the elderly poor are women, and one of the primary reasons is lack of private pension coverage. Women tend to move in

and out of the labor market, work at home, and earn less for what

they do. All of these factors make them likely to have very small

pensions or none at all.

I wanted to point out that the Teresa and John Heinz Foundation in Pennsylvania has just published a retirement guide for

women. This commonsense guide to retirement issues is excellent.

I will provide a copy for inclusion in the record with the approval

of the Chairman.

Mr. PORTMAN. Without objection.

Mr. COYNE. The problem of men and women without pensions is

not new, and Members of Congress have been concerned about it

for many years. My colleague, Chairwoman Johnson, has been particularly active in trying to solve this problem over the years. Despite our best efforts, many small business employees, low-income

workers, and women still do not have pensions. We need to focus

on helping these groups, which are the majority of the pensionless

and of the elderly poor.

Today’s hearing will give us an opportunity to discuss and analyze the administration’s fiscal year 1999 proposal for expanding

pension coverage by small businesses. We also have an opportunity

to consider Congressman Kleczka’s bill, H.R. 211. It addresses another critical issue in retirement security: The declining levels of

retirement health benefit coverage. We will also hear from a number of other individuals who have spent many years studying this

issue. I think they will give us a deeper understanding of the problems retirees and their employers face, but I hope that they will

also suggest solutions.

We need to find a way to help those who need it the most: Small

business employees, women, and the working poor.

Thank you, Mr. Chairman.

Mr. PORTMAN. Thank you. And without objection, the guide from

the Heinz Foundation will be entered into the record.

[The information follows:]
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
f

22

Mr. PORTMAN. Our first witness is David M. Strauss, Executive

Director of the Pension Benefit Guaranty Corporation I think

you’re going to give us a little background on PBGC, and then I

hope some commentary on the SAFE plan, the SMART plan, and

other defined benefit plan proposals that are out there.

Mr. Strauss.

STATEMENT OF DAVID M. STRAUSS, EXECUTIVE DIRECTOR,

PENSION BENEFIT GUARANTY CORPORATION

Mr. STRAUSS. Thank you, Mr. Chairman, Members of the Subcommittee.

I appreciate the opportunity to appear before you today to speak

about the importance of defined benefit pension plans for America’s

workers. I want to thank the Subcommittee Chairwoman, Mrs.

Johnson, for holding this hearing for the interest that she and the

other Members of the Subcommittee have in the retirement security of America’s workers, including workers in the Nation’s most

dynamic economic sector, small business.

As the Executive Director of the PBGC, I have set three priorities for the Corporation. Today, I want to concentrate on one of

those priorities: Promoting defined benefit pension coverage. But

first, let me briefly address the other two—safeguarding PBGC’s

solvency and making PBGC a premier customer service agency.

Regarding my first priority, PBGC’s solvency, the corporation

had its first surplus in 1996, and we fully expect to report good

news again this year, when we release our annual report later this

month. The single employer program, which as late as 1993 was

running a deficit of nearly $3 billion, has now achieved a surplus

that can serve as a cushion for future economic downturns. Mr.

Chairman, your Subcommittee’s efforts in enacting the Retirement

Protection Act of 1994 have been an important factor in the single

employer’s program current sound financial condition. The multiemployer program also continues to be in good shape, with a surplus since 1982.

My second priority is to make the PBGC a premier customer

service organization, not only for the workers and the retirees we

protect, but also for the employers that pay our premiums and for

the pension professionals who advise them. In my written testimony, I have provided you with a number of examples of steps we

have taken to improve our customer service.

Now, let me turn to my third priority, which is the theme for this

afternoon’s hearing, ‘‘Promoting defined benefit pension coverage

for American workers.’’ Mr. Chairman, I have a very personal

knowledge of just how valuable a defined benefit pension can be,

especially for an older worker.

My father, who turned 88 last month, is that older worker. He’s

lived all of his life in North Dakota, and was a meat cutter in a

grocery store when he retired at age 63 without a pension. He then

took a part-time job for $1.75 a hour as a janitor at the local high

school. For the first time in his life, he was covered by a defined

benefit pension plan. He was making $6.25 an hour when he retired a second time, 15 years later.
23

The pension my father earned during those 15 years now pro- vides him with $169 a month, a supplement of over 20 percent to

his Social Security benefit. As the Subcommittee Chairwoman,

Mrs. Johnson, has pointed out, we know how difficult it is for seniors to live on Social Security alone. So this pension of $169 a

month makes a real difference. In addition, if my father dies before

my mother, the pension plan will provide her with the survivor

benefit for the remainder of her life. So I know from my father’s

experience how important a predictable, secure benefit for life can

be, even one that may seem to many people a relatively small

amount of money. I also know from my father’s experience that a

worker is never too old for a defined benefit plan and that a defined benefit plan can make a great deal of difference even for

workers making very modest salaries.

Mr. Chairman, today too many American workers, including the

huge cohort of baby boomers edging ever closer to retirement, have

either no retirement savings or inadequate savings. And some have

very few years left in which to save.

Defined benefit plans can offer a solution to this problem, but the

number of defined benefit plans offered by small- and mediumsized employers has decreased substantially. As Mrs. Johnson, the

Subcommittee Chairwoman, has pointed out when she joined with

Congressmen Fawell and Pomeroy to introduce SAFE, the low level

of pension coverage for workers in small business is particularly

troubling, given that small business provides most of the new jobs

in today’s work force.

Millions of small business employees have no employment-based

way to provide for their retirement. As opposed to over 60 percent

of workers in large firms, only 20 percent of workers in firms with

fewer than 100 employees have pension coverage. To help bridge

this gap, we agree with Mrs. Johnson that small business needs a

defined benefit retirement plan that is easy to administer.

Defined benefit plans have many advantages for workers and

their spouses. They provide predictable, secure benefits for life.

Sometimes we forget that defined benefit plans can also help employers. For example, they promote company loyalty and help retain valuable workers. Today, many small business owners are

baby boomers, not far from retirement age. Often, their businesses

have only recently matured enough to be able to support a pension

plan. If the owner and his or her workers have not been covered

by an adequate retirement plan, it may now be too late to build

meaningful retirement savings through a defined contribution plan.

In the limited window that remains before retirement, a defined

benefit plan allows a small business to provide meaningful retirement benefits for its middle-aged workers, and for older workers

like my father, something difficult with only a SIMPLE or a 401(k)

plan.

An important step in expanding the number of defined benefit

plans is to enact legislation creating a simplified defined benefit

plan for small business. Mrs. Johnson’s proposal, the SAFE plan,

and the President’s proposal, the SMART plan, are similar. They

both combine some of the best features of defined benefits and defined contribution plans and remove major obstacles that have prevented small business from offering defined benefit plans.
24

Under both plans, funding would be more predictable. Administrative costs and complexity would be reduced. Reporting would be

simpler and benefits would be more understandable and portable.

Both proposals would also give older workers, like my father, a

chance to earn a meaningful benefit. At the same time, both would

provide the opportunity for workers to benefit from investment returns, an especially attractive feature for younger workers.

Mr. Chairman, I would like to mention three aspects of the President’s SMART proposal that I think are especially important.

First, SMART would provide for a true defined benefit plan with

a predictable lifetime annuity for the participant and spouse.

Second, SMART would provide for a fair distribution of benefits

between owners and their workers.

And third, SMART would provide workers in small businesses

with a PBGC guarantee, the same protection we provide to other

workers in defined benefit plans.

Although the funding requirements of the SAFE and SMART

substantially reduce the risk to the worker, there are still circumstances that could result in a loss. We believe, therefore, that

these plans should be insured by the PBGC. America’s workers

have come to expect a PBGC guarantee and to rely on the PBGC

when their plans fail. The PBGC cannot guarantee these plans

without an insurance premium; however, because these plans, by

their design, may pose less risk, PBGC proposes that they pay a

substantially reduced premium.

Mr. Chairman, the administration looks forward to working with

Congress on a bipartisan basis, as we did in enacting the Retirement Protection Act in 1994 and SIMPLE in 1996. We need to give

small business a workable defined benefit plan before this Congress adjourns.

I thank you again for allowing me the opportunity to testify before you this afternoon, and I will be happy to answer any questions you may have.

[The prepared statement follows:]

Statement of David M. Strauss, Executive Director, Pension Benefit

Guaranty Corporation

Madam Chairman and Members of the Subcommittee:

Good afternoon. I am David Strauss, the PBGC’s Executive Director. The Pension

Benefit Guaranty Corporation (PBGC), established as a federal corporation by the

Employee Retirement Income Security Act of 1974 (ERISA), protects the pensions

of about 42 million workers and retirees in about 45,000 private defined benefit pension plans. PBGC’s Board of Directors is chaired by the Secretary of Labor. The Secretaries of the Treasury and Commerce are also Board members. PBGC operates

two insurance programs, the larger single-employer program and the multiemployer

program. PBGC paid $824 million in benefits to over 200,000 people during FY

1997. Another 260,000 people will receive benefits when they retire in the future.

PBGC receives no funds from general revenues. Operations are financed by three

sources: (1) insurance premiums set by Congress and paid by plan sponsors; (2) investment income and assets from plans trusteed by PBGC; and (3) recoveries from

companies that formerly sponsored plans.

I appreciate the opportunity to appear before you today to speak about the importance of defined benefit pension plans for America’s workers.

I want to thank you, Madam Chairman, for holding this hearing and for the interest you and the other members of this Subcommittee have in the retirement security

of America’s workers, including workers in the Nation’s most dynamic economic sector—small business.

As Executive Director of PBGC, I am acutely aware of how essential PBGC insurance is to safeguarding the pension benefits of American workers. The impact of
25

what PBGC does takes on even a greater importance when you put faces to the

numbers, as I have recently had an opportunity to do. I have met with hundreds

of men and women in newly trusteed plans who worked for now-failed companies

they thought would provide secure employment and benefits for the rest of their

lives. You can imagine their relief when I was able to tell them that their benefits

were safe.

Since coming to PBGC, I have also had the opportunity to fully appreciate the

work of the Congress in enacting the Retirement Protection Act (RPA) of 1994. Your

efforts in enacting these reforms have been an important factor in PBGC’s shift

from being a federal agency with serious problems to an agency in sound financial

condition.

This turnaround in PBGC’s fortunes has now provided me with the opportunity

to address more general policy matters such as those before the subcommittee this

afternoon—how to increase the availability of defined benefit pension plans in the

crucial small business sector of our economy.

I set three priorities for myself as PBGC’s Executive Director:

• Safeguarding PBGC’s solvency;

• Making PBGC a premier customer service agency; and

• Promoting defined benefit plans.

Today, I want to concentrate on promoting defined benefit plans—but let me just

briefly address my other two concerns.

SAFEGUARDING PBGC’S SOLVENCY

Last year PBGC had its first surplus in history, and we fully expect to report good

news again this year, thanks to a healthy economy and good asset returns. The

single-employer program, which as late as 1993 was running a deficit of nearly $3

billion, has now achieved a surplus that can serve as a cushion for future economic

downturns.

The multiemployer program also continues to be in sound financial condition, with

a surplus since 1982.

But PBGC has to be ever vigilant because there are many factors that affect our

financial health that are beyond our control:

• We are always taking on new plans and assuming new unfunded benefit liabilities even when the economy is strong. In the last year alone we have trusteed pension plans with more than 50,000 participants.

• Changing economic conditions (such as a dip in the stock or bond markets)

could reduce the value of the assets we manage.

• Decreases in long-term interest rates have the effect of increasing the present

value of the benefits PBGC will pay for decades to participants of trusteed plans.

• And, of course, we have to be ready for economic downturns.

MAKING PBGC A PREMIER CUSTOMER SERVICE AGENCY

My second priority is making PBGC a premier service organization.

For workers and retirees:

• We operate a Customer Service Center with a toll-free telephone number, and

respond to about 100,000 inquiries a year.

• PBGC Customer Service standards require that phone calls be answered within

24 hours, letters within a week, and status reports be given if the response will take

longer.

• We use the Internet to locate missing participants so they can claim pensions

that are owed them. Since the program began in 1996, we have located nearly 1200

people owed over $5 million dollars.

• We have improved communications with retirees and deferred vested participants.

• We hold meetings with participants of newly-trusteed plans to explain PBGC’s

guarantees and the processing of their plans.

For premium payers and their advisors:

• We revised our premium compliance program to reduce the administrative burden on those we audit, and we reduced late payment penalties for plans that correct

underpayments before PBGC issues a written notice.

• We exempted small plans from reporting to PBGC on quarterly pension contributions.

• I established a ‘‘virtual town hall’’ through the Internet to communicate with

premium payers and pension professionals.
26

PROMOTING DEFINED BENEFIT PLANS

My third priority is, working with the Departments of Treasury and Labor and

others in the Administration, promoting defined benefit pension coverage for American workers.

Today too many American workers, including the huge cohort of baby boomers

who are edging ever closer to retirement, have either no retirement savings or inadequate savings. Some have very few years left in which to save. The statistics are

worrisome:

• About 50 million Americans—or nearly 50 percent of the private sector workforce—are not covered by an employer-provided retirement plan.

• Only 20 percent of small business workers are covered by a retirement plan.

• Many workers are not saving enough at a young enough age to fund their retirements adequately.

• Low wage workers often have the most difficult time setting aside savings.

Many workers have difficulty grappling with investment decisions.

Defined benefit plans offer a solution for many of these problems. But defined

benefit plans in small and medium-sized employers have decreased substantially.

Millions of small business employees have no employment-based way to provide

for their retirement. Only 20 percent of workers in firms with fewer than 100 employees have pension coverage, as opposed to 62 percent of workers in firms with

100 or more employees.

As you, Madam Chairman, pointed out last May when you, along with Congressmen Fawell and Pomeroy, introduced SAFE (H.R. 1656, the Secure Assets for Employees Plan Act of 1997), the low level of pension coverage for workers in small

business ‘‘is particularly troubling given that small business provides most of the

new jobs in today’s workforce...Small business needs a defined benefit retirement

plan that is easy to administer...’’

In 1996, the Administration and Congress worked on a bi-partisan basis to create

the SIMPLE, a 401(k)-type of plan for small business. I hope we can work together

again to give those same small businesses an additional option—a defined benefit

plan tailored to their needs.

DEFINED BENEFIT PLAN ADVANTAGES—WORKERS

Defined benefit plans have many advantages for workers and for employers. For

workers, they provide a predictable, guaranteed, lifetime pension for the worker and

often for the worker’s spouse.

By predictable I mean:

• Benefits at retirement are predictable.

• Benefits are not subject to the ups and downs of the stock and bond markets.

• Benefits at retirement are not dependent on the amount a worker contributes

to the plan.

By secure I mean:

• PBGC guarantees to pay most—often all—of the benefit if the plan cannot afford to pay for the benefits when the employer goes out of business.

• Older workers approaching retirement can earn a meaningful retirement benefit.

By lifetime I mean:

• The retiree is entitled to a monthly benefit for life no matter how long he or

she lives.

• The retiree’s surviving spouse is also entitled to a monthly benefit for life unless

both have elected otherwise.

DEFINED BENEFIT PLAN ADVANTAGES—EMPLOYERS

Sometimes we forget the worth of defined benefit plans for employers:

• They promote company loyalty and help retain valuable workers;

• While the employer bears the investment risks for the plan, favorable investment returns and economic conditions, such as we are experiencing now, reduce employer costs and make it possible to increase worker benefits at nominal cost; and

• An employer can provide meaningful retirement benefits for workers, even older

workers for whom the employer did not previously offer a retirement plan.
27

SMALL EMPLOYER DEFINED BENEFIT PLAN

Many small business owners are baby boomers not far from retirement age. Often

their businesses have only recently matured enough to be able to support a pension

plan. If the owner and his or her workers have not been covered by an adequate

retirement plan, it may now be too late to build meaningful retirement savings

through a defined contribution plan. A defined benefit plan can allow a small business to provide meaningful retirement benefits for its older workers, something difficult to do with only a SIMPLE or 401(k) plan.

An important first step in expanding the number of defined benefit plans is to

enact legislation creating a simplified defined benefit plan for small businesses as

you, Madam Chairman, the President, and other Members of Congress have proposed. These proposals combine some of the best features of both defined benefit and

defined contribution plans. The proposals remove some of the major obstacles to

small business defined benefit plans.

• Funding contributions would be more predictable—the employer would contribute an amount each year expected to fund the retirement benefit earned that year.

• Administrative costs would be lowered by reducing complexity and permitting

simpler reporting.

• Benefits would be more understandable to the workers.

Your SAFE and the President’s SMART are similar in many respects, and their

goals are the same—to create a simple small employer defined benefit plan. Both

SAFE and SMART:

• Give older workers the chance to earn a meaningful benefit even if they were

not previously covered by a plan.

• Provide benefits to low-wage workers who would have difficulty making contributions.

• Cover all workers with two years of service and $5,000 or more in compensation.

• Provide that employee benefits are 100% vested at all times.

• Can provide all workers the opportunity to earn greater benefits if investment

returns exceed expectations, an especially attractive feature for younger workers.

• Are portable.

As Executive Director of the PBGC, I would like to mention three aspects of the

President’s proposal that are especially important. First, SMART would provide for

a fairer distribution of benefits between owners and moderate and lower-income

workers. For example, SMART would limit the maximum compensation that may

be taken into account in determining an individual’s benefit for a year to $100,000

(indexed for inflation). Second, SMART would be a true defined benefit plan. It

would provide a lifetime annuity for the participant and spouse. Third, SMART

would provide workers with the same protections as other workers in defined benefit

plans—a PBGC guarantee.

The funding requirements of the SAFE and SMART substantially reduce the risk

of loss to the worker; however, there are still a number of circumstances that could

result in a loss, such as an employer not making the required contribution. These

plans should be insured by the PBGC. Since ERISA’s enactment in 1974, America’s

workers have come to expect a PBGC guarantee and to rely on the PBGC when

their plans fail.

PBGC cannot guarantee these plans without an insurance premium. However, because these plans, by their design, may pose less risk, PBGC proposes that they pay

a substantially reduced premium.

We look forward to working with you on a bi-partisan basis as we did in enacting

RPA in 1994 and the SIMPLE in 1996. Let’s give small business a simpler defined

benefit plan before this Congress adjourns.

I thank you again for allowing me the opportunity to testify before you this afternoon. I will be happy to answer any questions you may have.

Mr. P

Mr. C

ORTMAN

OYNE. Mr. Chairman, Richard Neal, a Member of the Sub-

. Mr. Coyne.

f

committee, asks that his statement be included in the record.

Mr. PORTMAN. Without objection.

Mr. COYNE. Thank you.
28

Mr. PORTMAN. Without objection, the opening statement is included in the record. Are there any other opening statements people would like to submit for the record?

[The opening statements follow:]

Opening Statement of Hon. Richard E. Neal, a Representative in Congress

from the State of Massachusetts

First of all, I would like to thank Chairwoman Johnson and Representative Coyne

for holding this very timely hearing. I think pensions are an extremely important

issue and an issue Congress should be able to address this year.

I believe in the concept that retirement is based on a three-legged stool which consists of personal savings, Social Security and pensions. Forty percent of retirement

income comes from Social Security. Nineteen percent comes from pensions and the

rest comes from savings. Last session of Congress, we addressed personal savings

by expanding individual retirement accounts (IRAs). Congressman Thomas and I

worked toward this expansion which was included in the Taxpayer Relief Act of

1997.

Lately, Social Security has received much attention and I think this is an issue

we need to address. I fully endorse the approach that President Clinton is taking.

It is a very simple concept—to put Social Security first. Recently, Congressman Rangel introduced legislation which would reserve any budgetary surplus for Social Security. On March 4, the Congressional Budget Office announced that by the end of

this year, we will have a budget surplus of $8 billion. This surplus should be used

to reduce the debt.

In the near future, we need to address Social Security, but in the immediate future Congress should take action to improve our current pension system. We should

make it easier for employers to offer pensions. Pensions should provide for more

than 19 percent of savings. We need to make individuals more responsible for their

retirement.

Our society has changed and no where are these changes more evident than in

the workplace. It is now more common for individuals to change jobs than to stay

with one firm for an entire career. This makes it extremely important for us to address pensions and especially the issue of portability. Changing jobs should not

drastically affect one’s pension.

Millions of Americans have no access to retirement plans. Only half of full-time,

private sector workers participate in an employer-sponsored pension plan. This results in 51 million American workers with no pension plan. Pension coverage has

only increased to 50 percent in 1993 from 48 percent in 1983.

Small businesses are less likely to have pensions than large businesses. While

only thirty percent of firms that employ between 25 and 49 employees have pensions, seventy-three percent of firms that employ over 1000 employees have pensions. Only 8% of Americans making below $10,000 per year have pension coverage.

Fewer women receive pensions than men. The percentage of the workforce covered

by a pension has stagnated in the last 20 years. Many firms cite complexity and

start-up costs as major reasons for not offering pensions.

Portability is important to improving our pension system. Five million people with

pension coverage change jobs every year. Many workers lose out on their pension

because they leave their jobs before their pension vests.

President Clinton’s budget included comprehensive pension proposals. The proposals are aimed at making it easier for employers to offer pensions and for employees

to retain pensions when switching jobs. The President’s proposals are targeted to

promoting pension plans among small businesses. These proposals build on past efforts of the President and Congress to simplify pensions. The President’s measures

would boost private pensions and individual retirement savings.

In the near future, I will be introducing the President’s pension proposals in the

form of legislation. This legislation will enhance workers’ ability to contribute to an

IRA by payroll deduction. The bill will provide a tax credit for small businesses with

fewer than 100 employees for the start-up costs of a pension plan.

The legislation creates new simplified defined benefit pension plans for small

businesses with fewer than 100 employees called the SMART plan. The SMART

plan is a broad based approach that provides participants with a guaranteed minimum annual benefit upon retirement. An employee’s benefit would be 100 percent

vested at all times. The bill allows for faster vesting of employer matching contributions to defined contribution plans. Vesting for the employer match would occur at

three years instead of five years. This should help with portability.
29

The bill will also include the expansion of right-to-know provisions for workers

and spouses and simplification proposals. These proposals will help reduce the paper

work associated with pensions.

The above described legislation is targeted to improve pensions in the areas where

I believe the most improvement is needed—coverage for small businesses and portability. Now is the time for Congress to act. We cannot over look the statistics. We

are beginning to face what has been commonly referred to as the ‘‘graying of America.’’ Within thirty years, one out of every five Americans will be over age sixty-five.

In thirteen years, the baby boomers will begin turning sixty-five. The baby boomer

generation consists of 76 million members and will result in Social Security beneficiaries doubling by the year 2040.

We need to take action now to make retirement more secure. I see no reason that

would prohibit Congress from passing legislation to improve our pension system.

The way I look at the three legged stool of retirement is that the pension leg is

wobbly. We can make that leg carry its weight by enacting pension proposals based

on those included in President Clinton’s budget. All three legs of the retirement

stool need to be strong.

I look forward to working with this Subcommittee and the full Committee on

making it easier for both employers and employees to have pensions.

f
30

f
31

Opening Statement of Hon. Gerald D. Kleczka, a Representative in

Congress from the State of Wisconsin
32

mony, and we appreciate your comments, particularly on some of

Mr. PORTMAN. Mr. Strauss, thank you very much for your testif

the legislative proposals that are before us. On SAFE versus

SMART, just one simple question. Do you think we can reconcile

the differences between these two, or should we be looking at two

separate defined benefit plans and moving forward and offering,

therefore, more options?

Mr. STRAUSS. I think that they serve different purposes and work

well in combination with each other.
33

Mr. PORTMAN. So you’re suggesting that perhaps this Subcommittee look at enacting both proposals—pushing both proposals

forward?

Mr. STRAUSS. I’m sorry. We’re talking about SAFE and SMART

rather than SIMPLE and this defined benefit concept?

Mr. PORTMAN. Right. I’m talking here about the administration’s

proposal, which is the SMART plan, and Chairwoman Johnson’s

proposal, which is the SAFE plan.

Mr. STRAUSS. I think that since the SAFE and SMART plans

contain many of the same features that it should be easy to work

out our differences.

Mr. PORTMAN. We should give directives on them.

Mr. STRAUSS. Yes, sir.

Mr. PORTMAN. That certainly would be my hope, and then we

would have one—one—vehicle for smaller businesses on the defined

benefit side and one on the defined contribution plan, the SIMPLE

plan.

Does it make sense, my second question would be, to reconcile

some of the differences between the SIMPLE plan and the SAFE

plan or the SAFE/SMART plan? As I read the SAFE plan, it seems

to have many of the same criteria, which I like. Many of the same

definitions, which I think is very helpful. But do you think that

there is a need to try to present one single, coherent pension vehicle, or should we be providing these two separate options?

Mr. STRAUSS. Again, the differences between SIMPLE and the

SAFE/SMART proposal—I think that the SIMPLE and the defined

benefit proposal serve different purposes. And for older workers—

like my father, for example—there is not enough of a window for

them to save enough, early enough——

Mr. PORTMAN. Under the SIMPLE plan.

Mr. STRAUSS [continuing]. To guarantee them a set benefit for

life. And so I think that these vehicles serve different purposes, but

I think they work well in combination.

Mr. PORTMAN. But you would hope that a smaller business would

be able to offer both of these options and some workers would want

to pick up both?

Mr. STRAUSS. What we’re trying to do here is to provide the option for those small businesses who are looking for more choices to

have the option to provide a true defined benefit plan if that’s

something that they think works for their workers.

Mr. PORTMAN. In your statement, you said that you thought that

these small business plans should be insured through the PBGC

and you said that the premium might be less because you thought

that they might offer less risk. I would say that there is less risk

in these plans certainly, and I wondered if you could give us a

sense of what the premium might be?

Mr. STRAUSS. I’ve recommended $5 for the premium.

Mr. PORTMAN. Five dollars versus roughly $19?

Mr. STRAUSS. Nineteen dollars, which is the flat rate premium

for the single employer plan.

Mr. PORTMAN. One other general question I have, then I want to

get to my colleagues. Maybe we’ll have time to come back and talk

about some other issues. But on the issue of PBGC generally, in

your testimony you didn’t address the issue of premiums directly.
34

You do have a surplus. I want to commend you for that, and I

guess we should commend our economy for that. And it is on a

sound financial basis. The question is, when you have a surplus,

how much of a cushion is necessary for what you described in your

testimony as an economic downturn that might occur. What’s your

present thinking of how much of a surplus the agency should maintain before we begin to look at the issue of premium discounts or

premium reductions?

Mr. STRAUSS. I think it’s important to point out, at the outset

here, that we’ve only been operating in the black for 2 years out

of the 24 years that we’ve been in existence.

Mr. PORTMAN. You’ve done better than the Congress. We spent

almost 30 years trying, and haven’t gotten there yet. But go ahead.

Mr. STRAUSS. And I think that, in order to determine how much

of a cushion is enough, it requires us to look at all of those factors

that influence our bottom line. So premium levels would be one factor. Our investment strategy would be a factor. The interest rates

that we use to evaluate the liabilities of the plans that we insure

is another factor. And so, we’re just at the beginning of that process right now. But I don’t think that a 2-year snapshot is an adequate basis on which to make long-term decisions about the appropriate premium level. And I think that we need to be prepared in

the event of a downturn. When we look at this 2-year snapshot,

we’re looking at very ideal conditions. The economy is doing very

well. Our PBGC investments are doing very well. There have been

very few large plans that have terminated. And I think that we

just need a longer horizon on which to base a judgment about adjusting premium levels. I don’t think that every time there’s a

slight change, there should be an adjustment in the premium levels.

Mr. PORTMAN. Let me push you just a little further on that. Can

you give us a sense of whether that’s 5 or 10 years, and or what

the surplus level might be as a percentage perhaps?

Mr. STRAUSS. I think that there’s one other point that I should

make with respect to premium levels. Because of the provisions in

RPA, from 1994, with the stricter funding provisions, the variable

rate premium stream is already coming down. And in the year

2000, when the variable rate premium is based 100 percent of the

30-year Treasury rate, it will roughly cut the variable rate premium in half. So a premium reduction is already occurring. Also

with respect to the flat rate premium—the flat rate premium was

set at $19 in 1981—or 1991, I should say. And so, if you just look

at the impact of inflation on that, there’s been a 15- or 20-percent

reduction there. So, I think that all of those factors will need to be

considered, and we have more sophisticated models that we’re developing now to help us in this respect. And if I come back next

year, I can give you much better answers to this question.

Mr. PORTMAN. I will push no further. Mr. Coyne.

Mr. COYNE. Thank you, Mr. Chairman.

Director, I wonder if you could touch on what the biggest challenges facing you and the Pension Benefit Guaranty Corporation is

today?

Mr. STRAUSS. I think that the biggest challenge is to make sure

that we have an adequate cushion to protect the agency in the
35

event of an economic downturn. That is, as I indicated, when you

look at our history, we’ve only been in the black for 2 years out of

24 years. And that in order for the plan sponsors and the participants whose benefits we insure to have confidence in the system,

I think that it’s important that we maintain an adequate cushion

to protect the agency in the event of an economic downturn. If an

economic downturn occurs, there will be significantly more plans

terminating and the PBGC assets will be worth less. And so, that’s

the eventuality that I think we need to be prepared for, and I think

that that’s our biggest challenge.

Mr. COYNE. I wonder if you could try to give us some idea of why

employers are beginning to steer away from defined benefit pension

plans and instead setting up defined contribution plans?

Mr. STRAUSS. I think that the reasons that the employers are

steering away from defined benefit plans are basically three.

They’re concerned about the complexity of those plans. They’re

concerned about the high administrative costs, and they’re concerned about unpredictable funding levels. And I think that all of

those issues are addressed by the SAFE/SMART vehicles that this

Subcommittee is considering.

Mr. COYNE. What did PBGC do administratively to get the agency off the Federal Government’s high-risk list?

Mr. STRAUSS. Well, I think that when you look at the improvement in our financial condition that it’s basically threefold. I think

the reforms that were passed in 1994—that provide for stricter

funding limits, the participant notification provisions, taking the

cap off the variable rate premium—are one set of factors that have

had a positive impact on our bottom line. We’ve also done enormously well off of our trust fund investments. That’s had a positive

effect on our bottom line. And I think that those have been the

major factors—that coupled with the improvement in the economy

overall—that result in our condition being vastly improved.

Mr. COYNE. Thank you very much.

Mr. PORTMAN. Mr. English.

Mr. ENGLISH. Thank you, Mr. Chairman. And I’d like to say, Mr.

Strauss, we appreciate your being here. I have a couple of specific

questions that I wanted to vent with you to improve my understanding.

First, in your view, what is the likely level of risk for a defined

benefit plan maintained by a small versus a large business?

Mr. STRAUSS. Well, I think, when we look at the vehicles that the

Subcommittee is considering here, that because of the particular

design of these plans the risk would be very small. And so, it’s a

design that’s not very risky, and there are small amounts of money

involved here. So the combination poses very little risk to the

PBGC.

Mr. ENGLISH. With regard to the SMART plan, I think that other

witnesses today intend to take issue with limitations on compensation for determining an individuals annual benefit, which I think

is established in that proposal at $100,000. Why do you consider

this to be an important positive attribute of the President’s plan,

if you do?

Mr. STRAUSS. Well, in developing our plan, we attempted to target that part of small business where the coverage was the poorest,
36

and the costs were the highest. And so that was our primary focus.

But, I would be happy to look into any issues that you would like

to raise in this respect.

Mr. ENGLISH. Well, I hope you’ll have an opportunity to review

some of the other testimony that’s coming before us today, because

I think some of it speaks directly to that. My final question: You

indicated in your testimony that with the SMART plan the small

business participating may have to contribute extra funds if the

participant chooses an annuity form of benefit in the SMART

Trust. The SAFE plan, as I recall, does not include such a provision

because of concerns that this possible additional liability might discourage small businesses from participating under the terms of this

plan. A small business has limited purchasing power when buying

an individual annuity contract. If we followed the SMART plan approach here, would the PBGC be willing to consider developing

methods by which small businesses adopting the plan could purchase annuities which would be more competitively priced?

Mr. STRAUSS. I’m aware of the issue that you raise, and it’s

something that we’re looking into and that we’re attempting to address. Yes, sir.

Mr. ENGLISH. Thank you. Well, in that case, we’ll look forward

to the end result of your efforts.

Mr. Chairman, I appreciate the chance, and I’ll yield back the

balance of my time.

Mr. PORTMAN. Thank you, Mr. English.

Mr. Kleczka.

Mr. KLECZKA. Thank you, Mr. Chairman.

Mr. Strauss, how large is the surplus that you’re talking about

today, in dollars and cents?

Mr. STRAUSS. One week from Monday we will release our annual

report for last year, and that will give you an accurate number

with respect to our surplus. It’s going to be released 1 week from

Monday.

Mr. KLECZKA. OK, what is the ballpark on that number coming

out?

Mr. STRAUSS. I think that, while the auditors and the lawyers

are going over the number, the best answer that I can give you is

that clearly it’s going to be a positive number, and we can release

the exact number 1 week from Monday.

Mr. KLECZKA. OK, now this is your second year of a surplus?

Mr. STRAUSS. And this will be our second year of a surplus, yes,

sir.

Mr. KLECZKA. What was the surplus last year?

Mr. STRAUSS. Sorry.

Mr. KLECZKA. What was the surplus last year?

Mr. STRAUSS. $869 million.

Mr. KLECZKA. OK, and you assume that we’re going to have another surplus this year?

Mr. STRAUSS. Yes, sir, it will be a larger number, I can assure

you of that.

Mr. KLECZKA. That was my next question.

Mr. STRAUSS. Thank you.

Mr. KLECZKA. OK, so it would be more than $869 million or

would it be lower than that amount?
37

Mr. STRAUSS. No.

Mr. KLECZKA. OK, that’s clearly good news because we’ve been

working with PBGC for years. Every time you’ve appeared before

the Subcommittee—or your predecessors—it was always to indicate

the bad news and this Subcommittee had to either adjust the premium or do other things to make the fund solvent.

Are we still experiencing problems with the big four industries

in this country, that is, steel, airlines, tire rubber, and auto? Are

we still seeing underfunding in those segments of our economy?

Mr. STRAUSS. Yes. Generally, the answer is yes.

Mr. KLECZKA. So, if in fact, we would see a downturn in the economy of any prolonged degree, we would probably see problems in

those four areas; thus, that surplus would be gone in a short while,

as I understand it. Is that not somewhat accurate?

Mr. STRAUSS. It’s entirely possible. And so when you look at the

surplus in terms of our large plans that have terminated historically, the surplus would equal three or four of the large terminated

plans.

Mr. KLECZKA. OK. So before we start talking about reducing premiums, let’s just hold on and see what happens to the economy on

a longer basis, knowing very well that there are still a lot of large

plans that are underfunded. And actually, the large plans tend to

be the problem plans, not the small business plans like my friend

Congressman English talks about. Small business plans usually do

not pose a big liability problem even though they might have some

problems. Is that somewhat accurate?

Mr. STRAUSS. Yes. It is.

Mr. KLECZKA. OK, let me ask you, in the past you produced a

list of 50 major corporations in the country who had severely underfunded pension plans. Do you not publish that list anymore?

Mr. STRAUSS. We did away with the top 50 list because we were

singling out companies that were meeting all the legal requirements that did not necessarily pose any risk to the participants in

their plans or to the insurance program. I think that here’s an example of where the new tools that we were given in the 1994 law

are working. So the stricter funding limits, the participant notifications, which I know that you’re very familiar with, where there is

a very high threshold. If a plan is less than 90-percent funded,

then the plan sponsor has to inform every single participant. When

you look at the plans that we’ve taken in historically at the PBGC,

only 2 percent of them have been funded more than 75 percent. So

this is a very high level—a very high threshold—at which participants are notified. And so I think that because of this better tool,

it made the top 50 list less necessary.

Mr. KLECZKA. But publishing the top 50 list did not mean that

these 50 major employers of the country were deficient in their

payments or whatever. It’s just that the plan was underfunded.

And I think the 1994 law, as you indicated, helped promote more—

or a better—level of funding of plans.

Now part of that law, as you indicated—and let me just ask you

to expand—was a notification to employees who have a definite

part in this whole program and that notice was to provide an

English—simple English—explanation to employees that their plan
38

was somewhat underfunded. Is that being accomplished and what

is the result of that?

Mr. STRAUSS. It’s being accomplished. It’s working well. Many of

the plans are using the model notice that we provided. There have

been a significant number of cases where plans have funded up to

the 90-percent level so they don’t have to send out the notice. And

so, we know that that’s working very well. We continue to monitor

it and think it’s a great success story.

Mr. KLECZKA. I think it’s an important part of that law because

at least it gives the employee the heads up that there could be a

problem. Prior to that law change, the only time they received notice of a problem with their plan is when they received a notice

from the PBGC indicating that you were taking over the pension

plan.

One last question, Mr. Chairman, if I might. Even though your

agency has no responsibility over retiree health plans or retiree

benefits in the life insurance area, there was some thought on the

part of this Member of Congress to expand at least the health area

because of a problem we had in Milwaukee with the Pabst Brewing

Company. More recent, many of us are receiving letters and calls

from Sears’ former employees because Sears is planning on reducing dramatically the life insurance benefit that they had promised

to their employees. Now, it’s not a responsibility of yours; but nevertheless, is there any problem with the funding or the balances in

the Sears retirement program, so these retirees might receive another notice from you or from Sears that there’s now a problem

with the retirement benefit?

Mr. STRAUSS. I’ll be happy to check that for you and get back to

you on that.

Mr. KLECZKA. OK, I’d appreciate that because we are receiving

letters from constituents.

[The following was subsequently received:]

Funding Level of the Sears Retirement Plan

The principal defined benefit retirement plan of the Sears, Roebuck Co., as of Jan- uary 1, 1996, the latest available data, was 80 percent funded. The plan had $1.8

billion in assets and $2.2 billion in liabilities. The plan was then paying benefits

to 32,000 retirees. It had 154,000 active participants and another 41,000 vested participants who were no longer employed by the company.

Mr. P

Mr. K

ORTMAN

LECZKA. Thank you, Mr. Chairman, for your indulgence.

. Mr. Tanner.

f

Mr. TANNER. Thank you very much, Mr. Chairman.

Mr. Strauss, thank you for being here. I read with great interest

your statement. I only have one question. You talk about the fact

that only 20 percent of workers within firms with fewer than 100

employees have some sort of pension coverage. You talk about the

SAFE and SMART plans and go on to say that ‘‘PBGC cannot

guarantee these plans without insurance premium; however, because these plans, by their design, may pose less risk, we propose

that they pay a substantially reduced premium.’’ Could you expand

on that idea, please?

Mr. STRAUSS. I think that, with respect to the PBGC premium—

from some of the discussions that I’ve had with the pension profes-
39

sionals who would actually be marketing these plans, they feel that

having a plan that’s insured by the government will make it more

marketable. And as long as we can keep the premium modest, the

PBGC insurance would actually add value to them and make it

easier to sell these things.

Mr. TANNER. You haven’t fleshed that out. It’s just that the marketing aspect of it is the driving force?

Mr. STRAUSS. Well, what we’ve tried to do is to work with the

practitioners who are actually going to be selling these things, to

get a sense from them what sort of vehicle makes sense. And I can

recall a discussion that I had with one benefits consultant where

he said that the typical small business that would be interested in

something like this was a small business that has matured to some

extent, where the owner of the business has a corps of longtime,

loyal employees and that we have to create incentives for that

owner and for that corps of longtime employees to get them to

think about offering this sort of defined benefit pension plan.

The advantage of creating those incentives and getting them to

consider a plan like this, as I indicated earlier—I was talking about

the situation of my father who, very late in life, got a job when he

was working as a janitor that was covered by a defined benefit pension plan where, because of that, he now has a small amount of

guaranteed income that he can look forward to for the rest of his

life. And so, what we’re trying to do here is to create incentives for

the average small business owner who makes about $55,000 a year

to offer the sort of defined benefit plan that will benefit him, the

corps of workers who’ve been with them for a long time, but also

the low-paid workers like my father.

Mr. TANNER. OK. I follow, you.

Thank you, Mr. Chairman.

Mr. PORTMAN. Thank you.

Mr. Strauss, just a couple of followup questions. First, to your

line of questions with Mr. Tanner. It seems to me that it would

make sense for the SAFE plan—for the SAFE/SMART plan, however it comes out—I wonder if there’s a way that we can combine

those two acronyms to track as closely as possible the outlines of

the SIMPLE plan. And I think it’s fair to say that the SIMPLE

plan has caught on. It’s being explored, certainly by a lot of small

businesses in my district. I know it’s selling like hot cakes. But one

of the things I noticed, as I looked today at the testimony, is that

whereas, the SAFE plan, again, tries to follow the criteria and the

definitions as closely as possible and also the compensation levels

as closely as possible, the SMART plan imposes some lower limits.

In particular, under SAFE, the annual compensation which can be

considered under the plan is the same as it is under SIMPLE—

$160,000. And SMART has a lower limit. I assume that’s targeted

more toward folks who really need it and people at the low-income

levels. Do you think that that lower limit is going to discourage

some adoption of the plan and shouldn’t we be, as I stipulated earlier, trying to keep this as simple as possible so that the two plans

have as much as possible the same criteria?

Mr. STRAUSS. We certainly agree about the need to keep it as

simple as possible and make it as easy to administer as possible.

Regarding the pension professionals that we deal with, the signifi-
40

cant issues that they raised are that they are concerned about complexity of these programs, and they’re concerned about the steep

administrative costs. And so, that’s clearly what we’re trying to address here, and to do it in a way that the net result is a predictable, secure benefit for life. And so, those are the objectives that

we’re working toward.

What we focused on here is that part of small business where the

coverage is the lowest, where the costs were the highest. We’re

willing to expand that dialog with you.

Mr. PORTMAN. All right. So there’s some flexibility there, and we

have the same goal in mind which is to keep it as identical as possible to the other criteria.

Jumping to another issue quickly—multiemployer plans. I know

you’ve got a lot of different areas that you have to look into, and

this is one of them. I think there are about 2,000 multiemployer

plans out there that are under your purview. And about 50 or so

that are underfunded.

Having heard about this from my district where we’ve got one of

these underfunded plans—their concern is that plan trustees are

granting benefit increases in these plans even though they again

are chronically underfunded and increasing the liability even

though there is no control over the situation by the employer. Is

there a way to address this? Maybe by designing a solution that

only affects the underfunded plans? Making sure a plan is adequately funded before there are new benefit increases? Have you

focused on this area? Do you have any suggestions as to how to address the problem?

Mr. STRAUSS. I haven’t focused on this area. I can tell you that

overall the system is sound—we’re required by law to do a 5-year

study. That in the last 5-year study, the funding level of these

plans overall was shown to be improving, that out of these 2,000

plans, we’ve only taken in—I think—19 in our entire history.

Under this program, unlike the single employer program, we’ve

been reporting a surplus since 1981.

Mr. PORTMAN. Right.

Mr. STRAUSS. And so I’d be happy to look into your specific questions and get you the answers.

Mr. PORTMAN. OK. Mr. Kleczka, do you have any additional

questions?

Mr. KLECZKA. Yes, Mr. Chairman. Thank you very much. Mr.

Strauss, one of the ideas I had and wanted to share and get your

reaction was to expand the area of responsibility for the Pension

Guaranty Corporation and either change the name to reflect Pension and Benefit Guaranty Corporation or Pension and Healthcare

Benefit Guaranty Corporation I’m thinking now of a situation in

my district with the Pabst Brewing Company, wherein they promised early retirees and regular retirees healthcare benefits. Then 1

day, with no notice to its retirees, Pabst Company was no longer

going to provide benefits to its retirees. These people were left high

and dry. For the ones who were over 65, we did pass legislation in

the last budget bill which waived the penalty for these folks getting

into Medicare. Prior to that, there would have been a financial penalty for those folks. But for other employees, especially those in

their fifties, there was no place to go except to the private market,
41

and if there were any preexisting conditions, these employees were

faced with a very, very high premium.

Now for companies that offer and give health care benefits, I

would like to get your thoughts on the possibility to provide a similar system like we do for the pensions where there would be a

small premium paid into your agency to cover those employees who

would lose their health benefits which were part of their retirement

plan. Knowing full well that a pension is very, very important in

your later years, but so is health care coverage. If you made your

retirement decisions based on the probability or the guarantee that

your employer is going to offer them and suddenly its taken

away—you’re in some difficult straits.

So the question is, what would be your reaction to expanding the

PBGC to include not only pensions but also benefits that were

guaranteed and provided by the employer, like health?

Mr. STRAUSS. As tempted as I am to expand my mandate here

a little bit this afternoon, I’ll be happy to look into those issues for

you and get back to you. I’m aware of your concerns and we can

look into them.

Mr. KLECZKA. What would be your reaction to having this additional responsibility?

Mr. STRAUSS. I think that there’s an agency within the Department of Labor—the Pension Welfare Benefits Administration—that

has primary jurisdiction in this area——

Mr. KLECZKA. Well, in the situation with the Pabst Brewing

Company went to them and they had no authority over the situation either. So that clearly is not the backup agency to protect employees’ benefits.

Mr. STRAUSS. I’ll be happy to look into this some more and get

back to you on it.

Mr. KLECZKA. Thank you.

[The following was subsequently received:]

The Administration is very concerned about the plight of retirees when an employer drops their health insurance coverage. The termination of health benefits can

be especially serious for pre-Medicare eligible retirees who may find it impossible

to obtain affordable coverage elsewhere. However, we do not believe the answer to

this problem is for the Pension Benefit Guaranty Corporation to insure retiree

health benefits.

In the absence of comprehensive health reform, a federal guarantee of retiree

health benefits is not practical and would potentially create an open-ended liability

for the United States Government. Retiree health benefits are very different from

defined benefit pension plans. Unlike defined benefit pension plans, it is very difficult to accurately determine present value of benefits in a particular case. Retiree

health benefits are typically not funded in advance, not vested, and are often terminable at the discretion of the plan sponsor. The benefit terms can also differ widely, with differing employee contribution levels, co-payments, and other benefit and

treatment provisions. The potential liability associated with these benefits can vary

widely depending on the terms of the plan, and assumptions of health costs and

technology growth.

Providing a Federally guaranteed retiree health benefit program in the absence

of more comprehensive plan standards could actually encourage termination of these

health plans. It would subsidize employers who break their promise by taking over

their benefit payments for them. The PBGC guarantees payment of promised pension benefits when employers in financial distress are unable to fulfill those promises.

The Administration believes employers must clearly state the terms of their retiree health benefit promise, and be held accountable to that promise. Too often, employers have been able to cut retiree health benefits under fine-print technicalities

or disclaimers in their plan documents, even though they are contrary to assurances
42

of coverage they have made to their employees and retirees. The Administration has

aggressively intervened in litigation in these cases by filing amicus briefs supporting

the rights of retirees to be heard and for preserving the health benefits of retirees

involved.

A more practical and less disruptive approach than a Federal guarantee is to provide retirees the opportunity to obtain affordable health coverage, especially where

their benefits have been terminated. The Administration has recently proposed legislation to require that retirees age 55 or older whose benefits are terminated be

allowed to buy into their former employers’ plans for active employees at a price

not greater than 125% of the average cost for the group. The legislation would offer

retirees who lose benefits access to affordable coverage until they become eligible

for Medicare. It would also limit employers’ ability to walk away from their obligations to their retirees.

Mr. P

[No response.]

ORTMAN. Other questions.

f

Mr. PORTMAN. Mr. Strauss, thank you very much. We’d look forward to working with you on ‘‘SIMPLE,’’ ‘‘SAFE,’’ and ‘‘SMART,’’

and other ways to expand retirement savings opportunities. We’d

like to call our next panel now. Mr. Strauss, thank you very much

for your testimony this afternoon.

Our next panel consists of a number of experts in the pension

area. Ron Merolli, who’s director of Pension Legislative and Technical Services, National Life Insurance Co., Montpelier, Vermont.

He’s here on behalf of the American Council of Life Insurance.

Gregory Moore, deputy director of the Pension Rights Center.

James V. Leonard, vice chairman, Engineering Employment Benefits Committee, on behalf of the Institute of Electrical and Electronics Engineers of the United States. Gail S. Shaffer, who’s executive director of Business and Professional Women/USA. Michael

E. Callahan, who’s president of PenTec, Inc., Cheshire, Connecticut, on behalf of the American Society of Pension Actuaries. Gregory J. Fradette, Sr., the agency principal of the Greg Fradette

Agency, Inc., of Bristol, Connecticut.

Are you all situated? Mr. Merolli, we’d like to start with you this

afternoon, if we could. Your full statements can be made part of the

record. We ask you to summarize your oral remarks in 5 minutes.

So you’ll see the green light come on and then moving to the orange and finally to the red after 5 minutes. We ask you to keep

your formal presentation to those 5 minutes, but would be happy

to add anything else to the record. Mr. Merolli.

STATEMENT OF RON E. MEROLLI, DIRECTOR, PENSION

LEGISLATIVE AND TECHNICAL SERVICES, NATIONAL LIFE

INSURANCE CO., MONTPELIER, VERMONT; ON BEHALF OF

AMERICAN COUNCIL OF LIFE INSURANCE

Mr. MEROLLI. Thank you, Mr. Chairman. My name is Ron

Merolli of National Life Insurance Co., Montpelier, Vermont. I’m

speaking today on behalf of the American Council of Life Insurance, ACLI. ACLI is the major trade association of the life insurance industry. We are very concerned with issues involving the

continued viability and expansion of our retirement system. We

would like to express our appreciation to the Subcommittee for inviting us to share our views and those of the other speakers on the

obstacles facing small employers who wish to establish retirement
43

programs, and on a retirement program that hopefully will overcome many of those obstacles. We have also submitted written testimony for the record.

We have been involved in assisting small businesses in fulfilling

their retirement objectives for many years and fully appreciate

their obstacles. For years, the incentives for establishing retirement programs have been eroded by almost annual legislation that

used our pension system to raise revenue to pay for unrelated programs. The constant burden of complex regulations and evertightening restrictions in order to meet short-term revenue objectives historically discouraged small business participation. As a result, plan formation, particularly in the defined benefit arena, declined significantly. Small businesses often do not have the financial resources to hire high-priced consultants to design or maintain

their plans. Therefore, it’s critical that their pension expenses be

used primarily for providing retirement income.

In the last several years, the Small Business Job Protection Act

of 1996 and the Taxpayer Relief Act of 1997 brought changes that

are very favorable to individual savers and to small businesses.

We’re very happy that there is strong bipartisan support for reforms, particularly in a simplified, defined benefit type program for

small business owners. We are particularly interested in and support the concept contained in H.R. 1656, the Secure Assets for Employees Plan Act of 1997, the SAFE Plan, and identical legislation

contained in both S. 883 and S. 889.

SAFE will encourage small businesses to adopt defined benefit

plans. We also believe SAFE is superior to the SMART plan proposal which is included in the administration’s fiscal year 1999 proposed budget as we will discuss later. SAFE can be either an annuity or a safe trust. The ACLI supports permitting all types of business entities to participate in SAFEs—including corporations, nonprofits, governmental units and other unincorporated entities—

similar to how SIMPLE is handled. Under SAFE, each year the

employer contributes the amount necessary to fully fund a benefit

for any current or prior year of service that is earned by the employee in that year, provided the employee earns at least $5,000 in

compensation, whether or not the employee is working on the last

day of the year. To accomplish this, the proposal uses age 65 as the

retirement age. Current mortality and expense assumptions are

used and the funding of benefits are determined assuming a 5-

percent rate of return.

However, while we favor SAFE, we are concerned with that 5

percent guarantee. We feel there should be a reasonable range of

3 to 5 percent. If the basis for the guarantee is 5 percent, insurers

will need to make long-term investments that have yields higher

than 5 percent in today’s very low interest rate environment. If interest rates drop further, 5 percent causes financial difficulties. The

trend is down and 5 percent could put insurers at long-term risk.

We are conservative investors—investing mainly in high-quality

bonds and mortgages. The interest earned on the investments is

competitive. Therefore, to guarantee an interest rate for the long

term of 5 percent—when long-term rates are currently hovering at

less than 6 percent and where they could decrease to less than 5
44

percent, raises serious concerns. If rates are declining, this may

tempt insurers to take more credit risks.

A SAFE annuity is approved by each State and their primary

concern is how products impact a company’s financial bottom line.

It may be tough to get a product approved in a State with a longterm guarantee of 5 percent. Also based on an informal survey, we

found no company that currently guarantees 5 percent. The full

guarantee should be historically sustainable which it would be at

3 percent—that’s what most companies guarantee.

What we could do though is offer 3 percent and also use products

where employees share in the investment returns of the insurer’s

general account. The SAFE annuity contract holder could do better

in years when returns are better.

We do not feel that PBGC insurance is needed for SAFEs.

SAFES are always fully funded and there’s no need for PBGC coverage. We also feel that SAFE plans should be fully portable. We

are encouraged that there’s bipartisan support for a simplified defined benefit plan. However, we feel that the SAFE plan is superior

to the SMART plan.

SMART, which uses a trust only, and not an annuity, specifically

excludes professional service employers. It can’t be established if

the employer maintained another defined benefit plan in the last

5 years. Matching contributions will be limited to 4 percent. It unnecessarily requires PBGC premiums. It doesn’t allow past service

credit—which I think is very important for 50-year-old employees

who wanted to make up time to get their plans funded in time for

their retirement, it uses an unrealistic $100,000 compensation

maximum, and it has a low-benefit percentage. In addition to

SAFE, there are other proposals that we support as well—including

relaxing the top-heavy rules, repeal of the 150-percent current liability funding limit—and others.

We applaud Congress and the administration for embracing the

concept of a simplified defined benefit approach and we promise to

work diligently with you to implement a workable program. Thank

you very much.

[The prepared statement follows:]

Statement of Ron E. Merolli, Director, Pension Legislative and Technical

Services, National Life Insurance Co., Montpelier, Vermont; on Behalf of

American Council of Life Insurance

My name is Ron E. Merolli. I am Director of Pension Legislative and Technical

Services for National Life Insurance Company at the Home Office in Montpelier,

Vermont. I am speaking today on behalf of the American Council of Life Insurance

(the ACLI).

The ACLI is the major trade association of the life insurance industry, representing 532 life insurance companies. These companies hold 89% of all the assets of the

United States life insurance companies and 90% of the insured pension business.

With such a large commitment to the retirement security of millions of Americans,

the insurance industry is vitally concerned with issues affecting the continued viability and expansion of the nation’s private retirement system.

I would like to express our appreciation to the members of the Committee for inviting us to state our views on the obstacles facing small employers who wish to

establish retirement programs and on an exciting new retirement program that

hopefully will overcome many of those obstacles.

My company and other ACLI member companies have been deeply involved in assisting small businesses in fulfilling their retirement objectives for many years.

Thus, we have a full appreciation of the difficulties small businesses have faced in

meeting those objectives. These small businesses have had to wade through minefields of complex tax and labor laws and regulations. For many years, the incentives
45

for establishing retirement programs have been eroded by almost annual legislation

that used our private pension system to raise revenue to pay for unrelated programs. Legislation was crafted not to enhance retirement security for present and

future generations, but as a way to offset non-related federal expenditures to meet

budget goals. The constant burden of complex regulation and ever tightening restrictions on contributions and benefits in order to meet short term revenue objectives

has historically discouraged participation by many small businesses in the private

pension system. As a result, qualified retirement plan formation, particularly in the

defined benefit arena, has declined significantly.

Qualified plans are costly for small businesses, that often do not have the financial resources to hire high priced consultants to design and maintain their plans.

The reporting, disclosure, and administrative requirements imposed by federal laws

and regulations are very complex, which often has translated into increased costs

that are too burdensome for many small employers to absorb. It is critical that the

small business owner’s pension contributions are used primarily for providing retirement income to retirees and not for administering the plan.

However, with the passage of the pension and benefits provisions of the Small

Business Job Protection Act of 1996 (SBJPA96) and the Taxpayer Relief Act of 1997

(TRA97), small businesses finally had something to cheer about! The onerous family

aggregation rules and the Code section 415(e) combined plan limits were repealed,

401(k) plan testing safe harbors and other simplifications were enacted, the highly

compensated employee and compensation definitions were simplified, various reporting and disclosure rules were eliminated, traditional IRAs were enhanced and the

new ROTH and SIMPLE IRAs were created, to name but a few of the changes favorable to both individual savers and to small businesses.

Nevertheless, much work still needs to be done, and we are very encouraged that

there is strong bipartisan support for additional pension reform initiatives, including specific initiatives for small businesses, particularly in one area where the need

is greatest. (We list other measures we believe will encourage small businesses to

adopt and maintain pension plans at the end of the testimony.) While many of the

recent enhancements have focused on ‘‘defined contribution type’’ programs such as

SIMPLE, SEPs, and various types of profit sharing plan designs, one area that still

needs addressing is the concept of a simplified ‘‘defined benefit type’’ program for

small business owners. Small business plan coverage is still woefully inadequate

and defined benefit plan coverage is still shrinking. Therefore, it’s encouraging that

both Congress and the Administration have embraced the view that what’s needed

now is a new simplified, tax favored defined benefit type retirement plan to complement the already established SIMPLE defined contribution plan.

We have examined several proposed plan designs, and we are particularly interested in and support the concept contained in H.R.1656, the ‘‘Secure Assets For Employees (SAFE) Plan Act of 1997’’ and in the identical legislation contained in both

S.883 and S.889. The ACLI believes that SAFE will encourage small business employers to adopt defined benefit plans and reverse years of defined benefit plan erosion. We believe the SAFE plan is superior to the Secure Money Annuity or Retirement Trust (SMART) plan proposal as included in the Administration’s fiscal year

1999 proposed budget, as we will discuss later. The ACLI supports expressly permitting all types of business entities to participate in SAFE plans, including corporations, S corporations, non-profits, governmental units, and unincorporated partners,

sole proprietors, and owner employees. We do have one major concern with the

SAFE proposal.

The ACLI is concerned with the requirement in H.R.1656 that a 5 percent interest

rate be used in computing the amount required to be contributed by an employer

each year under a SAFE Annuity. We believe that the legislation should provide for

a reasonable range of interest assumptions of 3 to 5 percent that can be used to

fund benefits.

If the underlying interest basis for the guaranteed retirement benefit is 5 percent,

insurers will need to make long term investments that have yields in excess of 5

percent, which is difficult in today’s low interest rate environment. Moreover, if interest rates were to continue to drop in the future, the 5 percent guarantee could

cause insurers financial difficulties. Although no one can predict how interest rates

will move, it is interesting to note that the annual change of the net rate of return

on the general account assets of insurance companies over the past ten years has

been negative 2.2 percent, and for 1995–96 was negative 1.9 percent. The trend is

clearly down and the 5 percent interest rate guarantee could put insurers at considerable risk for the long term.

Our industry recognizes that our annuity products are designed to provide long

term financial protection and security. We are conservative investors, investing

mainly in high quality bonds and mortgages, and the interest earned on these in-
46

vestments is competitive. Therefore, to guarantee an interest rate for the long term

(5 percent), when long term rates are currently hovering at less than 6 percent and

where the very real possibility exists that they will decrease to less than 5 percent,

raises serious concerns for our industry. Moreover, a SAFE Annuity will have to be

approved by each state’s insurance commissioner, and their primary concern is how

any new product impacts a company’s financial condition. Companies may very well

have difficulty getting a product with a long term guarantee of 5 percent interest

approved in the states in which they do business. Also, based upon an informal survey of various annuity providers, we found no company that currently guarantees

a 5 percent interest rate. The floor guarantee should be at a rate which is reasonable to believe will always be sustainable based on historical records, which is 3 percent. That is the floor rate that most companies are currently guaranteeing in their

products.

If it is felt that a 3 percent guarantee is too low, the other option is to allow employers to choose a participating SAFE Annuity. Such a product could offer a 3 percent guarantee and provide the employees an opportunity to share in the investment returns of the insurer’s general account, thereby assuring that the SAFE Annuity contractholder could do better than the guaranteed rate of return in years

when the general account returns are better.

PBGC INSURANCE

The Council agrees that PBGC insurance coverage should not be required in any

SAFE plan. A SAFE Annuity is a fully annuitized defined benefit, and consistent

with present law annuity rules, should be exempt. The cost of PBGC insurance coverage is an additional expense that often makes defined benefit plans unaffordable

for many small employers.

PORTABILITY

Since each participant’s benefit is kept in a separate account, all benefits in all

SAFE plans are fully portable. Portability of pension assets is critically important.

The small business area is where many employees enter the job market, where

many new jobs are created, and where substantial turnover occurs. Ease of movement for SAFE plan assets is a big plus.

SAFE AND SMART

As mentioned earlier, the Council is encouraged that there exists strong bipartisan support for a tax favored simplified defined benefit program for small businesses. We have examined the alternative proposed by the Administration (The Secure Money Annuity or Retirement Trust (SMART)), and we believe that SAFE is

the better option for the following reasons.

1. SMART specifically excludes professional service employers from establishing

a plan, prohibits an eligible employer from establishing a plan if the employer maintained another defined benefit plan in the last 5 years, and limits matching contributions to 4% if SMART is maintained with a 401(k) plan.

These rules are counterproductive to new plan formation and will discourage participation in plans.

2. SMART would unnecessarily require a PBGC premium for trusts (albeit less

than for other defined benefit plans. SAFE imposes no such requirement.

3. SMART does not allow for any past service credit. SAFE does and this is a very

attractive feature for small business owners.

4. SMART uses an unrealistic $100,000 compensation maximum. SAFE uses the

current law qualified plan limit of $160,000 (indexed).

5. SMART’s minimum defined benefit is only 1 or 2 percent, increasing to 3 percent only during the first 5 years of the plan. SAFE’s benefit formulas are more realistic.

In closing, the Council believes that SAFE is an important step towards expanding retirement plans for small businesses, we believe that small plan formation will

increase if SAFE is adopted.

In addition to the SAFE proposal, we believe the following list of pension proposals will greatly simplify the pension rules for plan sponsors, particularly small businesses, and thus will lead to expanded pension coverage for employees.

A. Relax top-heavy rules

1. Repeal family attribution applicable to top-heavy rules

2. Employee deferrals not counted for purposes of top-heavy rules

3. Matching contributions satisfy top-heavy minimum contribution requirements
47

4. All 401(k) safe harbor plans deemed to satisfy top-heavy rules

B. Complete repeal of the 150% of current liability full funding limit

C. Allow plan loans for self-employed individuals

D. Repeal age 70 minimum distribution requirement for small business owneremployees (5% owners)

E. Expand retirement savings by repealing 25% of compensation limit for defined

contribution plans

F. Repeal multiple-use test for 401(k) plans (the defined contribution plan version of

section 415(e))

G. Simplification of Section 404 (pension deduction rules)

1. Allow plans to use section 415 definition of compensation for deduction purposes

2. Exclude employee 401(k) contributions from 15% deduction limitation

3. Repeal combined plan deduction limitation

ACLI and other trade associations that support small business hope this Committee will consider these proposals this year.

Our private pension system offers the best hope of providing the retirees of America’s small businesses with a secure and dignified retirement. A substantial number

of workers not covered by a retirement plan work for small employers in the private

sector. The ACLI applauds the fact that Congress and the Administration have embraced the concept of a simplified defined benefit approach for small business, and

we will work with you to implement such a program.

I very much appreciate being given the opportunity to deliver the ACLI’s views.

I am happy to respond to any questions you may have.

Mr. P

Mr. Moore.

ORTMAN. Thank you, Mr. Merolli.

f

GREGORY MOORE, DEPUTY DIRECTOR, PENSION RIGHTS

CENTER

Mr. MOORE. Thank you, Mr. Chairman. My name is Gregory

Moore and I’m the deputy director of the Pension Right Center

public interest group that works to protect and promote the pension interest of workers, retirees and their families. Thank you

very much for inviting us to testify on the critical issue of pension

coverage.

As Chairwoman Johnson noted in announcing this hearing, over

50 million U.S. workers have no pension coverage of any kind and

most of these work for small employers. Based on these numbers,

half of this country’s workers will retire with Social Security benefits as their sole source of income. Given that the current average

Social Security benefit is $8,900 annually—or $24.49 a day—it is

clear that Social Security alone cannot provide retirees with a decent quality of life.

While distressing, the fact that working Americans have so little

to rely on in their retirement years should come as no surprise. For

much of the past decade, emphasis on retirement income has shifted from employer paid pension plans to employee funded savings

plans. Yet all indications are that the typical worker in this country cannot put aside enough money to retire in a voluntary savings

plan early enough in their career to accumulate the amounts necessary to provide an adequate supplement to Social Security.
48

A person earning the median $28,000 a year needs to set aside

at least one-quarter of a million dollars for retirement. Yet most recent government statistics show that the typical household has

only $15,000 in their 401(k)-type plans. The lack of sufficient savings for retirement is understandable—even predictable—given

several trends in employee wages and benefits. Between January

1976—when many of ERISAs provisions became effective—and

January 1998, wages for production workers in this country declined 28.3 percent when adjusted for inflation. The declining value

of a paycheck, viewed in concert with dramatic increases and employee healthcare costs, goes a long way toward explaining why retirement savings are so low. Indeed, in light of these facts, it is almost unrealistic to expect American workers to choose to save.

Compounding the problem is the fact that small businesses face

numerous obstacles to establishing and maintaining defined benefit

plans. From the small business owners’ perspective, significant

startup costs, administrative expenses and demanding funding requirements can make traditional plans cost prohibitive. Lack of affordability and complex formulas limit the attractiveness of the defined benefit plans to even employees. Fortunately, several bills

now before Congress seek to address the legitimate, financial concerns of small businesses and of the retirement needs of those

workers.

One such bill is the SAFE bill. SAFE would provide small business owners with a simplified defined benefit option. SAFE plans

will allow employers flexibility in deciding from year to year whether they can afford to contribute—a very attractive feature for small

business owners. Employers would be permitted to give pension

credit for years worked before the plan started and spread the cost

of past service liability over as much as a decade. SAFE plans, unlike saving plans, assure that money will be set aside for individuals at all income levels. These plans would preserve retirement

money for retirement. It would provide professionally pooled management. Most of these SAFE provisions are typical features of the

traditional pension plans. At the same time, SAFE plans would

also include the most attractive features of 401(k)s. All contributions would be 100 percent vested. They would offer rules that are

simple; benefits that are portable; and formulas that are fair to

lower paid and shorter service workers.

The Pension Right Center supports the major concepts incorporated in SAFE proposals. Yet, we believe that this legislation

could be strengthened in a number of key aspects.

First, we urge you to adopt joint and survivor protection for the

SAFE annuity. Second, to provide Pension Benefit Guaranty Corporation insurance to safeguard benefits. Third, limit preretirement

cash outs that reduce retirement savings. To varying degrees, these

provisions are included in the administration’s SMART proposal.

The Center also strongly supports the adoption of a modified version of SAFE, but we don’t think it should be the exclusive proposal. We urge the Subcommittee to explore the pension bill of Senators Jeffords and Bingaman, Congresswoman Barbara Kennelly’s

legislation protecting women and the Pension Counseling Assisting

Act introduced by Congressman Charles Schumer.
49

Thank you for the opportunity to testify. I’d be happy to answer

any questions.

[The prepared statement follows:]

Statement of Gregory Moore, Deputy Director, Pension Rights Center
50
51
52
53
54

Mr. P

Mr. Leonard.

ORTMAN. Thank you, Mr. Moore.

f

STATEMENT OF JAMES V. LEONARD, VICE CHAIRMAN,

ENGINEERING EMPLOYMENT BENEFITS COMMITTEE, INSTITUTE OF ELECTRICAL AND ELECTRONICS ENGINEERS, INC.–

UNITED STATES OF AMERICA

Mr. LEONARD. Good afternoon, Members of the Oversight Subcommittee. I’m James V. Leonard from St. Charles, Missouri, and

I’m testifying here today as vice chair of the Engineering Employment Benefits Committee of the Institute of Electrical and Electronics Engineers/USA, IEEE–USA. I want to thank the Chair and

Members of the Subcommittee for holding public hearings on these

critically important issues.

The IEEE is a transnational, technical, professional society

whose membership currently includes more than 320,000 electrical,

electronics and computer engineers throughout the world. Of those,

219,000 reside in the United States. Of IEEE’s employed U.S.

members, nearly 70 percent work for private businesses. Of those

in the private sector, 80 percent are employed by midsize and large

companies and 20 percent by small businesses—and that’s up from

10 percent in 1989.
55

We have been looking into and working with legislative efforts in

the pension area since the enactment of ERISA in 1974. Over the

years, IEEE–USA has worked in concert with 17 other engineering

organizations under the auspices of the American Association of

Engineering Societies in support of major pension reform and retirement savings proposals. We have spearheaded efforts to organize a broad-based pension portability coalition to educate the

members of participating organizations, Congress and the public

about needed and proposed improvements and affordability of pension benefits. These problems must be fixed before the baby boom

generation begins to retire early in the next century. Legislation

has been introduced in both Houses of Congress that we think will

help expand pension coverage in the rapidly growing small business sector and at the same time offer promising solutions to the

vesting, affordability, retirement preservation, minimum benefit

standards and administrative complexity problems that IEEE

members are concerned about.

The SAFE Act. The purpose of the SAFE plan act, as introduced

last year by Representatives Nancy Johnson, Earl Pomeroy, and

Harris Falwell is to encourage small businesses who establish simple secure pension plans for their employees. SAFE incorporates

some of the best features from defined contribution pension plans

like the highly respected TIAA–CREF and for more traditional defined benefit plans. the result is a prototype defined benefit plan

that, unlike most others, is fully portable.

The SAFE proposal facilitates pension portability. SAFE protects

the real value—that is the purchasing power of earned benefits.

SAFE also insures preserved preservation of benefits for use in retirement. In addition, the SAFE proposal includes provisions permitting the accumulation of up to 10 years of past service credits

and simplified reporting and administrative requirements that

should make it a particularly attractive benefit option for small

business.

The President’s Plan. As part of the fiscal year 1999 budget, the

Clinton administration has proposed some pension reforms of its

own. The President’s 1998 pension package also includes a new a

prototype defined benefit plan for small employers. With a few important exceptions, the President’s new secure money, annuity or

retirement trust—or SMART plan—bears a striking resemblance to

the SAFE plan. Like SAFE, the SMART plan will permit small

businesses to set up new, simplified tax-favored retirement account

that combines the best features of defined benefits and defined contributions plans. In addition, the minimum benefit under SMART

trust option would be guaranteed by the PBGC. The PBGC insurance feature should help to enhance the attractiveness of SMART

to some employers provided the required premiums are set and

kept at the low amount specified earlier of $5.00.

A major concern of IEEE–USA and for many other organizations

representing individuals who are maybe or work for professional

service providers are those provisions that could specifically exclude employers from eligibility to participate in a SMART plan. To

us it makes no sense for the administration to propose a pension

coverage expansion proposal that will deprive a growing part of the
56

small business community of an opportunity to participate in such

an important retirement savings plan.

And I will say in conclusion, the IEEE–USA urges the Oversight

Subcommittee to favorably support the SAFE Act and report it to

the Full Committee on Ways and Means and to recommend that

the bill in its present or amended form move forward expeditiously

for a vote in the House and Senate. I also request that the attached

comments and recommendations on SAFE prepared by Thomas C.

Woodruff, a resident of Norwalk, Connecticut be included in the

records for these hearings.

Thank you for your attention and I’ll be pleased to answer any

questions later on.

[The prepared statement and attachments follow:]

Statement of James V. Leonard, Vice Chairman, Engineering Employment

Benefits Committee, Institute of Electrical and Electronics Engineers,

Inc.–United States of America

1. INTRODUCTION

Good Afternoon, Madam Chairman and members of the Oversight Subcommittee.

I am James V. Leonard from St. Charles, MO. I am testifying here today as the

Vice Chairman of the Engineering Employment Benefits Committee of the Institute

of Electrical and Electronics Engineers—United States of America (IEEE–USA), one

of the world’s largest professional societies. I hold bachelor’s, masters and honorary

professional degrees in electrical engineering from the University of Akron, Washington University of St. Louis and the University of Missouri at Rolla and have

worked as an engineer for a major aerospace and defense company for 35 years.

The views expressed in my testimony are those of IEEE–USA and are not those

of my employer.

On behalf of the professional society that I represent, I want to thank the Chair

and the members of the Subcommittee for holding public hearings on such critically

important issues as the current availability of pensions to American workers, incentives for and obstacles to expansion of the nation’s voluntary private pension system, especially among small businesses, and the financial status of defined benefit

plans monitored by the Pension Benefit Guaranty Corporation (PBGC).

2. IEEE–USA’S INTEREST IN PENSION BENEFITS EXPANSION AND SIMPLIFICATION

ISSUES

The Institute of Electrical and Electronics Engineers is a transnational technical

and professional society whose membership currently includes more than 320,000

electrical, electronics and computer engineers in 147 countries throughout the

world. IEEE–USA promotes the technology policy and professional careers interests

of the 219,000 IEEE members who live and work in the United States.

Of IEEE’s employed U.S. members, nearly 70 percent work for private businesses;

10 percent work for Federal, state or local government agencies; 10 percent are

deans, professors or instructors at post-secondary educational institutions or work

for non-profit research centers. The remainder are self-employed and provide consulting services to businesses and government.

Of those in the private sector, 80 percent are employed by mid-sized and large

companies.Twenty percent work for small businesses, up from less than 10 percent

in 1989.

Although most of our members work for employers that offer tax-qualified pension

plans and other retirement savings programs, long-standing concerns about problems that limit the effectiveness of the nation’s voluntary private pension system

and the extent to which it discriminates against mobile workers have prompted

IEEE–USA to take an active part in legislative efforts to improve the system since

the enactment of ERISA in 1974.

Over the years IEEE–USA has worked in concert with 17 other engineering organizations under the auspices of the American Association of Engineering Societies

in support of major pension reform and retirement saving proposals. More recently,

we have spearheaded efforts to organize a broad-based pension portability coalition

to educate the members of participating organizations, Congress and the public

about needed and proposed improvements in the portability of pension benefits for
57

mid-career workers. A copy of the Coalition’s vision, mission and goals is included

as an attachment to our statement.

Pension problems that remain unresolved include: limited coverage, particularly

among small businesses; eligibility and vesting standards that penalize mobile

workers; impediments to the portability of benefits, especially from defined benefit

plans; the propensity of plan participants to spend rather than save pre-retirement

distributions; the absence of minimum contribution requirements needed to ensure

that retirees receive adequate benefits; and complex rules and regulations that

make it too costly for many employers—especially small employers—to establish and

administer pension plans for their employees.

Because employer-sponsored pensions are such an important supplement to Social

Security benefits and personal savings—especially for lower and middle income

Americans—these problems must be fixed before the baby-boom generation begins

to retire early in the next century. And to the extent that employer-sponsored pensions are such an important source of the savings needed for productive investment

in the nation’s economy, expanded coverage will also help to improve America’s technological competitiveness and its living standards.

Fortunately, legislation has been introduced in both houses of Congress that we

think will help to expand pension coverage in the rapidly growing, small business

sector and, at the same time, offer promising solutions to the vesting, portability,

retirement asset preservation, minimum benefits standards and administrative complexity problems that IEEE–USA members are concerned about.

Among the most innovative of these legislative proposals is the SAFE Plan Act.

3. THE SECURE ASSETS FOR EMPLOYEES (SAFE) PLAN ACT (H.R. 1656)

The purpose of the SAFE Plan Act—as introduced last year by Representatives

Nancy Johnson (R–CT), Earl Pomeroy (D–ND) and Harris Fawell (R–IL) and included in two important pension reform proposals in the Senate (the Retirement Income and Savings Act—S. 883 and the Retirement Security for the 21st Century

Act—S. 889)—is to encourage small businesses to establish simple, secure pension

plans for their employees.

SAFE incorporates some of the best features from defined contribution pension

plans like the highly respected TIAA–CREF and from more traditional defined benefit plans. The result is a prototype defined benefit plan that, unlike most others, is

fully portable. Here’s how it works:

A qualifying employer (with up to 100 employees) can establish a plan in the form

of an annuity or as a trust. All employees who received at least $5,000 in compensation from the employer during any two, consecutive preceding years and at least

$5,000 in the current year are eligible to participate. The employer can contribute

an amount equal to 1%, 2% or 3% of each eligible employee’s annual compensation

to the annuity or the trust. And once these contributions have been made, each employee’s benefit is fully and immediately vested.

The SAFE proposal facilitates pension portability (benefit transferability) by permitting terminating plan participants to: 1) use the assets held in a SAFE trust to

purchase a SAFE annuity that will pay the promised benefit at retirement; 2) to

make a direct trustee to trustee transfer to a subsequent employer’s plan; or to

transfer the present value of their SAFE assets into a rollover IRA.

SAFE protects the real value (purchasing power) of earned benefits by funding employer and employee contributions based on present year salaries and by providing

an opportunity for an enhanced benefit if the SAFE annuity or trust earns more

than 5% in any given year.

SAFE also ensures preservation of benefits for use in retirement by providing for

a direct transfer of SAFE assets to an annuity or to a rollover IRA should participants change or lose their jobs.

In addition, the SAFE proposal includes provisions permitting the accumulation

of up to ten years of past service credits and simplified reporting and administrative

requirements that should make it a particularly attractive benefit option for small

businesses.

4. PRESIDENT CLINTON’S SMALL BUSINESS PENSION PROPOSAL

As part of the Fiscal Year 1999 Budget, the Clinton Administration has proposed

some pension reforms of its own. In addition to a modest start-up tax credit designed to expand coverage by encouraging small businesses to establish some form

of pension plan (a Simple IRA, Simple 401(k) or Simplified Employee Pension) for

their employees and a new salary-reduction IRA, the President’s ‘‘1998 Pension

Package’’ also includes a new protype defined benefit plan for small employers. With
58

a few important exceptions, the President’s new Secure Money Annuity or Retirement Trust (SMART) plan bears a striking resemblance to the SAFE Plan.

Like SAFE, the SMART plan will permit small businesses (with up to 100 employees) to set up a new, simplified tax-favored retirement account that combines the

best features of defined benefit and defined contribution plans. As its title suggests,

the President’s Plan also offers annuity and trust options. SMART also allows employer contributions ranging from 1% to 3% of each employee’s compensation; provides for full and immediate vesting of benefits; guarantees a fully funded minimum

defined benefit with the possibility of a greater benefit if investment returns exceed

5%; facilitates portability and retirement asset preservation through the purchase

of annuities or direct transfers to an IRA or another employer’s plan; and simplifies

plan administration and reporting requirements.

In addition, the minimum benefit under the SMART trust option would be guaranteed by the Pension Benefit Guaranty Corporation, subject to payment by plan

sponsors of a reduced premium. This PBGC insurance feature should help to enhance the attractiveness of SMART to some employers, provided the required premiums are set and kept at low single digit levels.

Unlike SAFE, however, the President’s proposal does not provide for past service

credits.This omission is likely to make SMART less attractive than SAFE to many

small business owners.

A major concern for IEEE–USA and for many other organizations representing individuals who may be, or work for, professional service providers are those provisions that would specifically exclude such employers from eligibility to participate

in a SMART plan. In dynamic and rapidly changing American labor markets, especially in the high technology sector, more and more professionals—including engineers—are establishing small businesses or providing professional services as the

employees of small businesses. To us, it makes no sense for the Administration to

propose a pension coverage expansion proposal that will deprive a growing part of

the small business community of an opportunity to participate in such an important

retirement savings plan.

In our opinion, the proper way to address concerns about revenue losses and/or

potential abuses by some highly compensated individuals, is to establish a cap on

the compensation that is taken into account for benefits purposes—not by excluding

certain classes or groups of workers based solely on the way they are organized or

the nature of the services they provide.

In this regard, the SAFE proposal limits the maximum compensation to be taken

into account in determinining tax-favored benefits at $165,000. The SMART plan

sets a limit of $100,000.

Even though very few of our members would be adversely affected by the lower

compensation limit, we are concerned that a $100,000 unindexed cap may be a deterrent to participation by many small business owners, thereby unnecessarily limiting the effectiveness of SMART as an incentive for expanding pension coverage for

their employees.

In conclusion, IEEE–USA urges the Oversight Subcommitte to favorably report

the Secure Assets for Employees (SAFE) Plan Act to the full Committee on Ways

and Means and to recommend that the bill, in its present (or an amended form including appropriate spousal protections), be moved forward expeditiously for a vote

in the House and the Senate.

I have also requested that the attached comments and recommendations on

SAFE—prepared by Thomas C. Woodruff, a nationally recognized expert on pensions and retirement savings issues—be included in the record of these hearings.

IEEE–USA and other organizations in the American Association of Engineering

Societies and the Pension Portability Coalition will do our part to enlist additional

cosponsors and build the grass roots support that will be needed to enact this important legislation in the 105th Congress.

Thank you for your attention. I’ll be pleased to try to answer any questions that

you may have.

f
59

Pension Portability Coalition—‘‘You Can Take It With You’’

VISION STATEMENT

The Pension Portability Coalition envisions that by the Year 2000, portability will

be a reality.

Pension portability means:

• Pension Benefit Transferability

The ability to transfer pension assets or service credits from one plan to another

• Benefit Value Protection

• To minimize the impact of inflation on the purchasing power of pension benefits

• Retirement Asset Preservation

To encourage individuals to save rather than spend preretirement pension distributions

MISSION STATEMENT

In order to increase the productivity and retirement income security of American

workers, the mission of the Pension Portability Coalition is to Support Enactment

of Pension Portability Improvement Legislation

GOALS

To educate the members of participating organizations about needed and proposed

improvements in pension portability,

To identify and evaluate pension portability improvement options, including legislative and non-legislative alternatives, and

To inform concerned organizations, through Congressional, industry and public relations, of its evaluations in order to influence and provide a focus for improvements

in pension portability.

Remarks on Oversight of Pensions Including Plan Availability, Coverage

Expansion and Related Issues

f

BY THOMAS C. WOODRUFF, PH.D.

INTRODUCTORY REMARKS

My name is Thomas Woodruff. For the past twenty-four years, I have worked in

the private sector, the federal government, and academia on personal finance and

retirement planning issues. From 1978 to 1981, I was the Executive Director of the

President’s Commission on Pension Policy. That Commission found serious gaps in

pension plan participation in the U.S. workforce, particularly those working for

small businesses, and called for sweeping changes in our public policy toward our

public and private pension systems. After working as a Visiting Professor at Cornell

University, I directed a foundation-sponsored blue-ribbon panel called the Commission on College Retirement. The Commission on College Retirement’s work lead to

an overhaul of TIAA–CREF, the nation’s largest network of portable pension plans.

In my current capacity as a small business owner, I write extensively about personal finance and retirement planning issues, and provide consulting services to financial services companies and membership organizations such as the Institute of

Electrical and Electronic Engineers—United States of America (IEEE–USA).

PENSION PLAN PARTICIPATION IN SMALL BUSINESSES

First, I would like to say that I concur completely with the testimony delivered

today by the IEEE–USA. I will not repeat the points made in that testimony. I

would like to say that the SAFE Plan Act’s sponsors, Representatives Nancy Johnson, from my state of Connecticut, Earl Pomeroy , and Harris Fawell are to be commended for introducing this thoughtful and important piece of legislation.

I have just two points to make regarding public policy toward small business pension plans and the SAFE Plan Act. First, I believe that continuation of current policy will lead to the ongoing disenfranchisement of small business employees from

both the tax benefits and retirement income security that they derive from private

pension plans. And, second, I believe that a minor improvement to the SAFE Plan
60

Act could have a major positive impact on the retirement income security of those

who would participate in SAFE plans in the future.

FEDERAL POLICY TOWARD SMALL BUSINESS PENSION PLANS CONTINUES TO BE A

FAILURE

In its final report to Congress and the President in 1981, the President’s Commission on Pension Policy concluded: ‘‘ The most serious problem facing our retirement

system today is the lack of pension coverage among private sector workers.’’ The

Commission also said that the ‘‘lack of pension plan offerings in small businesses

is a major reason why pension plan growth is expected to continue to stagnate.’’

Among other reasons, the Commission cited the administrative expenses of actuarial, accounting, insurance and investment services necessary to operate small

plans, particularly defined benefit pension plans as a problem that needed to be

solved. In addition, the Commission found that eligibility and vesting requirements

in traditional defined benefit plans are just not well suited for small businesses due

to employee turnover as well as the uncertain life expectancy of many of these enterprises.

Unfortunately, in the seventeen years since the President’s Commission on Pension Policy issued its report, the low level of pension plan participation among employees of small businesses has remained virtually stagnant.

The SAFE Plan Act goes a long way toward addressing the administrative and

plan design problems faced by small business pension plans. While I would not expect that passage of the SAFE Plan Act would lead to pension plan coverage among

small businesses to approach the levels found in large businesses today, enactment

of the SAFE Plan Act would help remove a few unnecessary barriers to pension plan

formation and maintenance.

THE SAFE PLAN ACT COULD BE IMPROVED

Among the most important problems that we face in designing pension plans is

how to retain the purchasing power of pension benefits as they are earned during

the working years and when they are received during retirement.

In its Trust form, the SAFE Plan Act does provide that employees would benefit

from earnings in the Trust above the assumed interest rate used for funding the

Trust. This would provide the opportunity for them to begin retirement with either

an annuity or an income stream with purchasing power sufficient to maintain their

standard of living. However, no provision is made for similar participation in earnings or dividends with the SAFE Annuity form. In addition, the Act seems to presume that the annuities that would be purchased by the plan or by individuals at

retirement would be fixed annuities.

One of the lessons that I learned when I was President of the Commission on College Retirement was the importance of the ‘‘participating’’ and ‘‘variable’’ forms of

annuities. The TIAA–CREF pension plans have historically been funded with participating and variable annuities both as accumulating and pay-out annuities.

TIAA is essentially a large portfolio of fixed-income investments that promises to

its participant/investors a guarantee of principal plus a minimum rate of return.

Any earnings above the minimum guarantee are paid to participant/investors as

dividends. This is true both while the participants are working and when they

choose to annuitize the accumulated funds.

CREF was established in 1952 as a variable annuity with a diversified portfolio

of stocks as its underlying investment. Since 1989, CREF has diversified to include

a money market fund, and a variety of stock and bond portfolios. Unlike TIAA,

CREF does not guarantee a minimum rate of return. During the accumulation period, however, participants do receive the full benefit of the earnings in the underlying assets, much like participants in 401(k) plans. At retirement, participants also

have the option of converting their CREF accumulations into a variable pay-out annuity. Initial payments begin using a 4% assumed interest rate and adjustments are

made periodically, up or down, based on whether the investment returns reach or

exceed the 4% target.

TIAA and CREF annuities have served higher education and the non-profit community very well. The TIAA–CREF approach toward participating and variable annuities provides one example of how these annuity forms can help preserve the purchasing power of retirement benefits for workers. A modification of the SAFE Plan

Act to include participating and variable annuities both in the SAFE Annuity form

for active employees and for deferred and pay-out annuities for terminated employees and retirees would greatly enhance the benefits that could be paid by these

plans without increasing their cost to employers.
f

61

Mrs. JOHNSON of Connecticut. Thank you.

Ms. Shaffer.

STATEMENT OF GAIL S. SHAFFER, EXECUTIVE DIRECTOR,

BUSINESS AND PROFESSIONAL WOMEN/USA

Ms. SHAFFER. Thank you, Madam Chair and distinguished Members of the Subcommittee. We very much appreciate your allowing

us this opportunity to testify today.

I’m Gail Shaffer, executive director of Business and Professional

Women/USA, BPW/USA. We’re an organization representing

70,000 working women across the country. A third of our members

are businessowners. Our members are involved in more than 2,000

local chapters nationwide—at least one in almost every congressional district in the nation.

We applaud your Subcommittee for focusing on the status of our

Nation’s pension system and allowing us to bring to your attention

the particular ways in which the system’s current inadequacies disproportionately affect women in an adverse way. For working

women retiring, they come against a reality that might be characterized as the ‘‘showdown at gender gap.’’ There is already a 26-

cent gender gap in the average American wage scale and that is

compounded in retirement and translates into a 50 percent retirement gap. Obviously, this raises major equity issues and BPW has

had a longstanding interest in this issue. We have been working

not only to effect change on Capitol Hill, but also to educate our

members on the importance of retirement planning.

I’m very glad that Congressman Portman cited the publication in

Good Housekeeping magazine which hits the stand today. We will

be helping to distribute that, but it was really a project sponsored

by the Teresa and John Heinz III Foundation and the Women’s Institute for a Secure Retirement—also known as WISER—which has

been a partner to BPW as we work on these issues.

BPW was also a lead organization behind the passage in 1984 of

the Retirement Equity Act which was a critical first step in addressing some of the difficulties women have faced in gaining

greater access to pension benefits, particularly as spouses and widows. Since that Act was passed, there has been modest improvement in the rate of pension coverage for women which is certainly

a welcome development. However, that progress has been undermined by ongoing structural barriers and also by the overall shift

away from defined benefit or basic pension plans to do-it-yourself

defined contribution plans. This plan will leave women more financially vulnerable at retirement.

Several factors contribute to the fact that women are especially

vulnerable to economic insecurity in old age. The first is lifespan.

Although longevity is certainly generally considered to be a blessing, when it comes to retirement security the fact that women live

longer on the average than men becomes a disadvantage. Unless

women begin retirement with a bigger nest egg and a larger pension—which is rarely the case, the march of time and the pressures

of inflation will combine to make their later years—at best—uncomfortable and at worst—poverty stricken. Financial experts tell
62

Americans to plan to replace 70 to 80 percent of their income at

retirement. Unfortunately, that advice does not work for women

who are likely to need more than 100 percent of their preretirement income in order to maintain that security through a longer

lifespan.

Second, marital status is an important factor. Being single in old

age is somewhat financially risky, but for women it is much more

so. Consider that in 1992 only 6 percent of married women over

age 65 fell below the poverty line; but well over 20 percent of single

women fit the government’s definition of poverty. About 21 percent

of women who were either widowed or never married were poor;

while the percentage of divorced women in poverty climbed to 29

percent. It is important to keep in mind that as these women grow

older—as they reach, say 75 or 85—that poverty rate climbs, as

well.

Living alone is another factor. Three-quarters of men, age 65 and

older, live with a spouse; while only one-third of women do. A single elderly woman is twice as likely as an elderly man to be poor.

Furthermore, the Nation’s pension system is reflecting a work pattern that does not reflect the reality of women’s working lives.

Women over 25 tend to stay in jobs a shorter period of time and

leave the work force for care giving responsibilities, for example.

Women also are much less likely to have a pension and when they

do, they are concentrated more in low-wage service part-time jobs

and also more likely to work for a smaller business. So a majority

still are not covered by any pension at all.

The type of pension offered also makes a big difference. We recognize it is challenging to create the kind of ideal system we are

all looking for. But we are very concerned about the marked shift

from defined benefit plans toward defined contribution plans because it disproportionately hurts women. As I mentioned, women

earn on average less than three-quarters of what men earn. The

gender gap in wages means they have substantially less income

available to put in an IRA or 401(k) plan. Three out of four working women earn less than $23,000 annually. Only 10 percent of

them earn over $45,000 annually.

Second, studies have shown that women’s savings priorities are

focused on their children’s education, rather than retirement.

Third, they move in and out of the work force and from one job

to another more frequently and the lack of pension portability is a

very significant problem for them. And again, because their priorities focus on things such as education and medical emergencies,

they are much more likely to cash out their accumulations, rather

than keep those funds in the retirement account.

And finally, given the fact that women generally have smaller

amounts in their 401(k) account, they tend to be much more risk

averse in their investment approach. Consider that over age 40, the

average woman has accumulated only $7,000 in her 401(k), whereas the average man has accumulated $20,000 in his. That makes

the investment choices different and certainly the wage gap and

other factors have contributed to a less desirable set of options.

For all of these reasons, a defined contribution plan may not always be the best option for women who might, in fact, be better

served by the features in the defined benefit plan that guarantees
63

a certain minimum benefit; that does not place all the burden on

the employee; and is guaranteed to be paid out in monthly installments over the remainder of one’s life.

To be fair, defined benefit plans do not solve all of the problems

that women face in retirement planning—the wage gap, the career

interruption, stringent investment requirements still tend to depress the size of those pensions for women as compared to men.

And over the long term, inflation will certainly erode the value of

the benefit. But the annuitized format of these plans and their reliability and the participation of employers are features that are certainly important to women as current and future retirees.

Unfortunately, as everyone knows, small businesses particularly,

need plans that have a minimum of complexity and are affordable.

And as I said, one-third of our members are small business owners

and this is something we are very concerned with. That’s why we

are so pleased that Congresswoman Johnson, you and your colleague, Congressman Pomeroy and others have introduced H.R.

1656, the SAFE plan, to offer real pensions to workers that will

guarantee a minimum defined benefit and introduce portability and

other features that will be helpful. There are also important safeguards that we applaud in the bill that we feel will benefit both

the small business owner and the retiree.

Businesses feel that it’s truly helpful to small business owners

when they are spared much of the administrative burden and complexity associated with more traditional qualified retirement plans.

It is also designed, as others have said, to complement the SIMPLE

plan, which many small businesses have begun to offer. We are

very pleased there is bipartisan support for this plan. Our membership organization is a nonpartisan organization and we feel that it

is truly a very fine answer to a complicated problem.

We would also like to mention our support for another bill that

addresses problems for women achieving retirement equity—and

that is the Comprehensive Women’s Pension Protection Act—H.R.

766 and S. 320—which Congresswoman Kennelly has supported

along with Senator Carol Moseley-Braun. This is also important, to

address systemic barriers for women because it addresses specific

gender inequities within current law. For example, it provides for

automatic division of pension benefits in a divorce and also improves spousal consent provisions for 401(k)s.

We would be glad to comment further as the bills evolves in the

Congress. We very much appreciate this opportunity today and

particularly the focus that this Subcommittee has put on a very important issue to small business owners and to women facing retirement.

[The prepared statement follows:]

Statement of Gail S. Shaffer, Executive Director, Business and Professional

Women/USA

Good afternoon. I want to thank the members of the Subcommittee and particularly Congresswoman Johnson for inviting me today. I am Gail Shaffer, Executive

Director of Business and Professional Women/USA, an organization representing

70,000 working women across the country, a third of whom are business owners.

Our members are involved in more than 2,000 local chapters nationwide—at least

one in nearly every congressional district in the nation.

We applaud this committee for focusing on the status of our nation’s pension system, and for allowing us to bring to your attention the ways in which the system’s
64

current inadequacies disproportionately affect women. BPW has had a long-standing

interest in this issue, and we are working not only to effect change on Capitol Hill,

but also to educate our own members on the importance of retirement planning. In

this regard, it just so happens that the April issue of Good Housekeeping Magazine,

which hits the stands today, includes a guide for women on retirement planning

sponsored by the Theresa and H. John Heinz, III Foundation and the Women’s Institute for a Secure Retirement—also known as WISER. BPW is working in partnership with WISER and will be helping to disseminate thousands of these guides

across the country.

BPW was also a lead organization behind the passage of the Retirement Equity

Act of 1984, which was a critical first step in addressing some of the difficulties

women faced in gaining greater access to pension benefits, particularly as spouses

and widows.

Since the REA was passed, there has been some modest improvement in the rate

of pension coverage for women, which is certainly a welcome development. However,

that progress has been undermined by ongoing structural barriers and by the overall shift away from defined benefit, or ‘‘basic pension’’ plans to do-it-yourself, defined

contribution plans. This trend will leave women more financially vulnerable at retirement.

Several factors contribute to the fact that women are especially vulnerable to economic insecurity in old age. The first is lifespan. Although longevity is generally

considered to be a blessing, when it comes to retirement security, the fact that

women live longer than men is a disadvantage. Unless women begin retirement

with a bigger nest egg and a larger pension—which is rarely the case—the march

of time and the pressures of inflation will combine to make their later years at best

uncomfortable and at worst poverty-stricken. Financial experts tell Americans generally to plan to replace 70 or 80 percent of their income at retirement. Unfortunately, this advice doesn’t work for women, who are likely to need more than 100

percent of their pre-retirement income in order to remain secure throughout their

longer lives.

Marital status is another important factor. Being single in old age is somewhat

financially risky, but for women it is substantially more so. Consider that in 1992,

only six percent of married women over age 65 fell below the poverty line. But well

over 20 percent of single women fit the government’s definition of poverty. About

21 percent of women who were either widowed or never married were poor, while

the percentage of divorced women in poverty climbs to 29 percent. And it is important to keep in mind that as women grow older, as they reach 75 or 85 or older,

their poverty rate also climbs.

Living alone is another predictor of elderly poverty and women are much more

likely than men to live alone. Three-quarters of men age 65 and older live with their

spouse but only one-third of women do. A single elderly woman is twice as likely

as an elderly man to be poor. It is also important to note that our nation’s poverty

rate for single elderly women, which stands at about 18 percent, is by far the highest percentage in the industrialized world. And the breakdown of poverty rates

among minority groups is even more stark.

Although the nation’s pension system is gender-neutral, it was set up to reward

a work pattern that does not reflect the reality of women’s working lives. For example, women over 25 tend to stay in jobs an average of only 4.7 years, whereas pension vesting rules generally require five years on the job. Women are much more

likely to leave the workforce and three times as likely to work part-time to accommodate care-giving responsibilities. Women also earn less than men—an average of

26 percent less. The result of lower earnings means that women’s pension benefits

will be lower than those of men.

But most women aren’t lucky enough even to have a pension, regardless of its

size. Women are more likely to be working in low-wage, service, part-time jobs and/

or to work for small businesses—where pension coverage is the most sparse. Although about 48 percent of full-time female workers have some form of pension coverage, a majority still do not. And only 39 percent of all female workers are covered.

The type of pension plan that is offered also makes a big difference. We recognize

that it is challenging to create a system that covers as many workers as possible,

and that access to defined contribution plans is certainly better than no retirement

savings vehicle at all. But we are very concerned about the marked shift among employers away from defined benefit plans toward defined contribution plans. This

trend disproportionately hurts women, for a few reasons.

First, women earn, on average, less than three-quarters of what men earn, and

so they have substantially less income available to put in an IRA or a 401(k) plan.

Three out of four working women earn less than $23,000 annually. Even a disciplined saver will have trouble accumulating much in savings at that level. Second,
65

studies have shown that women’s savings priorities are often focused on their children’s education and not on retirement. Third, with women moving in and out of

the workforce and from one job to another more frequently than their male counterparts, the problems associated with lack of portability become particularly acute for

them. And again, because of priorities such as their children’s education and medical emergencies, women often opt to cash out their 401(k) accumulations when they

leave a job rather than keep the funds for retirement.

Finally, given the fact that women generally have smaller amounts saved in their

401(k) accounts and have less to fall back on from other sources, it is not surprising

that they are often more averse to riskier, albeit higher yield, investments. It is not

simply a lack of financial sophistication, it is actually a pretty rational behavior.

Consider that over age 40, the average woman has accumulated only $7,000 in her

401(k) whereas the average man has accumulated $20,000 in his. This is already

an exponential disparity which is further amplified as the effects of the wage gap,

compound interest and investment choices take their toll over time.

It must also be said that even in best-case scenarios, where women have saved

much, invested well, and have a sizable lump sum distribution available to them

when they retire, it is still incumbent on them to manage these assets so that they

will provide income for the remainder of their lives. If the market hits a prolonged

slump, if they make poor investment decisions or fall prey to unscrupulous financial

advisors, they could easily exhaust their assets late in life. And once the money is

gone, it is gone.

For all of the reasons outlined above, defined contribution plans may not always

be the best option for women, who might in fact be better served by the features

available in a defined benefit plan—what we think of when we think of a traditional

pension.

A defined benefit plan has a lot going for it as far as women are concerned. First,

it does not place all of the burden on the employee to plan and execute her retirement savings all by herself. It features a contribution by the employer. It is less

voluntary in nature and is a form of forced savings. It is also guaranteed to be paid

out in monthly installments over the remainder of one’s life, thus recipients are

much less prone to the potential catastrophes of poor asset management.

To be fair, defined benefit plans do not solve all of the problems women face in

retirement planning. The wage gap, career interruptions and stringent vesting requirements still tend to depress the size of women’s pensions as compared to men.

And over the long term, inflation will gradually erode the value of the monthly benefit. But the annuitized format of these plans, their reliability, and the participation

of employers are all features that are particularly important to women both as current and future retirees.

Unfortunately, as everyone in this room knows, the cost and complexity of defined

benefit plans has made them a difficult option for small businesses to pursue. The

statistics bear this out: only about 24 percent of firms with fewer than 100 employees, and 13 percent of firms with 10 or fewer employees, offer such plans. Given

that small businesses are creating the majority of the jobs in this country, it is clear

that we ought to make it easier for these firms to offer defined benefit plans.

That is why we are so very pleased that Congresswoman Nancy Johnson, along

with her colleague, Congressman Earl Pomeroy, has decided to address this problem

and introduce H.R. 1656, the Secure Assets For Employees Plan Act of 1997. The

SAFE plan provides a framework to enable smaller employers to offer real pensions

to their workers. The bill guarantees a minimum defined benefit, which as I have

stated is so critical for women. It also introduces portability to these benefits, so

that when an employee leaves her job, she can take her retirement savings with

her.

There are also important safeguards written into this bill. It requires that the

SAFE plans be fully funded and that the actuarial assumptions be conservative, so

that a minimum guaranteed benefit can be achieved. If the plan exceeds conservative expectations, the beneficiary receives higher distributions. Employees will be

able to keep track of their assets and their future retirement benefits through an

annual account statement. SAFE also ensures that employees’ benefits are 100%

vested at all times and that all plan participants are treated the same.

This bill is also extremely attractive to small business owners, who are spared

much of the administrative burden and complexity associated with traditional qualified retirement plans. SAFE is a much more affordable alternative to these plans,

and it is designed to complement the SIMPLE plan, which many small businesses

have begun to offer.

We are optimistic about the prospects of passing the SAFE bill in the foreseeable

future, because it enjoys bi-partisan support, and because the Clinton Administration has also indicated its support for this concept. We would like both Congress
66

and the Administration to know that BPW/USA supports this legislation and would

very much like to see it signed into law this year.

We would also like to mention our support for another bill that addresses the

problems women face in achieving retirement equity, and that is the Comprehensive

Women’s Pension Protection Act—H.R. 766 and S. 320. This bill was introduced in

the Senate by Senator Carol Moseley-Braun and in the House by your colleague

from Connecticut, Barbara Kennelly. The Senate version, S.320, has bi-partisan support, as Senator Olympia Snowe, with whom we have worked closely over the years,

is a lead co-sponsor of the measure.

The Comprehensive Women’s Pension Protection Act is important because in addition to attempting to address systemic barriers for women, it also addresses specific

gender inequities within current law. For example, it provides for the automatic division of pension benefits in a divorce unless otherwise specifically provided in the

settlement. Current law allows for division of pension benefits, but the process is

confusing and many women are not made aware of these rights until after a divorce

is final, when it is too late. The bill also improves spousal consent protections for

401(k)’s so that they are on a par with those pertaining to defined benefit plans

when it comes to lump sum distributions. It expands options for joint and survivor

annuity benefits so that either surviving spouse will have a benefit equal to twothirds of the benefit received while both were living, and requires that both spouses

be fully informed of their options before a decision is made. Currently, survivor benefits are half of the previous benefits, which can be a significant financial burden

for women, who are more likely to be the survivor and less likely to have other

sources of income.

I hope the members of this subcommittee will take a look at this legislation and

consider lending their support to it as well. We believe that for anyone who is truly

interested in improving gender equity and the economic status of older women,

many of the provisions contained in this bill are must-see language.

In closing, I would like to once again commend this Subcommittee for focusing attention on this critically important issue. The implications of inadequate pension

coverage are far-reaching—indeed, inter-generational. If we address this issue now

and take steps that will narrow the gap between those retirees who are financially

and those who are poor, we will not only be making an investment in our citizens,

but also ensure a much smaller tax burden in the future.

Thank you for your kind attention to my remarks. I’d be pleased to take any questions you may have.

Shaffer.

Mrs. JOHNSON of Connecticut. Thank you very much, Ms.

f

Mr. Callahan, it’s a pleasure to welcome you back to the Subcommittee from Cheshire, Connecticut but also someone who was

very instrumental in helping this Subcommittee write the SIMPLE

legislation about a year ago. Welcome.

STATEMENT OF MICHAEL CALLAHAN, PRESIDENT, PENTEC,

INC., CHESHIRE, CONNECTICUT; ON BEHALF OF AMERICAN

SOCIETY OF PENSION ACTUARIES

Mr. CALLAHAN. Thank you. Good afternoon, Madam Chairwoman, and thank you for inviting the American Society of Pension

Actuaries, ASPA, to testify before your Subcommittee on this important subject.

My name is Michael Callahan and I’m an enrolled actuary and

president of PenTec, Inc.—a pension and actuarial consulting firm

located in Cheshire, Connecticut.

PenTec provides services to retirement plans for over 500

Connecticut-based companies. I’m also a past-president of the

American Society of Pension Actuaries on whose behalf I am testifying today.
67

ASPA is an organization of over 3,000 professionals who provide

actuarial consulting services to approximately one-third of the retirement plans in the United States. The vast majority of these

plans are for small businesses.

Ten years ago, 90 percent of the plans that my company, PenTec,

administered were defined benefit plans. Due to extremely complicated laws and regulations, less than 10 percent of the plans

PenTec currently services are defined benefit plans. The same

change in ratios are found throughout ASPA’s membership. During

this same period, funding of employee benefits had shifted from the

employer to the employee as illustrated by the growth in the 401(k)

plans.

I congratulate the Chair and Congressman Pomeroy for introducing a simplified defined benefit plan that employers can use. The

SAFE plan is the first congressional step since ERISA to establish

a defined benefit pension program that is designed for small business employees. The SAFE plan is secure, fully portable and avoids

most of the complex rules and regulations that choke small businesses that want to offer retirement plans for their employees. The

unique feature of the SAFE plan is that in addition to a defined

retirement benefit, it also gives employees the opportunity to obtain larger retirement benefits if plan assets perform better than

conservative expectations. Further, the SAFE plan can provide employees with up to 10 years of credit for service prior to the start

of the plan.

This allows for small business employees, in effect, to catch up

with respect to the retirement savings. This is important because

typically a developing small business cannot afford a retirement

plan for several years. The catchup provisions of the SAFE plan

are critical to the retirement planning of longstanding employees

who helped build that small business. By contrast, defined contribution plans, like the new SIMPLE plan, do not allow for such

catching up. Further, we are very disappointed in the administration’s SMART plan proposal because it does not allow for any prior

service credit. The security of the plan to the employees cannot be

understated either. Under the SAFE plan, the small business must

always fully fund employees’ benefits.

Further, the SAFE plan proposal provides fully portable benefits,

which is extremely important given today’s mobile work force. Benefits are fully vested in automatic IRA conversions, plus high penalty taxes for early withdrawals increase incentives for employees

to maintain their pension assets.

I congratulate the Clinton administration for supporting expansion of small business defined benefit plans by including the

SMART plan proposal in fiscal year 1999 budget. Although there

are many similarities between SMART and SAFE, there are some

important differences that I’d like to highlight.

First, although SAFE requires no PBGC insurance, I do believe

a modest PBGC premium could in fact enhance the marketability

of the plan since it would give small business employees added security. However, such premiums should recognize the greatly reduced insurance risk to the PBGC and be substantially less than

the PBGC current premium.
68

ASPA also agrees with the PBGC testimony that the small business defined benefit plan should guarantee an annuity form of benefit if elected by the participant. However, given the difficulties

small plan sponsors have when purchasing individual annuity contracts, ASPA strongly suggests that this Subcommittee consider the

proposal described in ACLI’s testimony to allow the sponsor of the

SAFE plan to select from a range of interest rates from 3 to 5 percent upon adoption of the plan. This would allow the SAFE plan

to be funded at levels that more closely resemble the individual annuity market.

In addition, we would suggest that the PBGC be given authority

to develop methods for small business owners to purchase individual annuities on a more competitive basis. For example, the PBGC

could facilitate negotiating master contracts with insurance companies which could be used for small business owners sponsoring the

SAFE plan. The annual limit on compensation that may be taken

into account for benefit purposes under the SAFE plan is $160,000.

The same limit in current law that applies to SIMPLE plans and

all other qualified retirement plans should also apply to simplified

defined benefit plans.

Under the SMART plan, the proposed annual compensation on it

is only $100,000. ASPA strongly believes that there is not justifiable policy reason for imposing a special lower compensation limit.

Because it is a defined benefit plan, benefits provided to the rank

and file workers under both the SAFE and the SMART plans are

significant and substantially greater than that would be provided

under the SIMPLE plan. The owners of small businesses need an

incentive to provide these greater benefits to rank and file workers.

I congratulate this Subcommittee’s interest in retirement savings

and thank you again for the opportunity to testify on this extremely important subject.

[The prepared statement follows:]

Statement of Michael Callahan, President, PenTec, Inc., Cheshire,

Connecticut; on Behalf of American Society of Pension Actuaries

INTRODUCTION

Good afternoon. Thank you for inviting me today to testify on this important subject. My name is Mike Callahan. I am an enrolled actuary and president of PenTec,

a pension consulting and actuarial firm located in Cheshire, Connecticut. PenTec

provides retirement plan services to over 500 small businesses located in the state

of Connecticut. I also am past president of the American Society of Pension Actuaries (ASPA) on behalf of whom I am testifying today. ASPA is an organization of over

3,000 professionals who provide actuarial, consulting, and administrative services to

approximately one-third of the qualified retirement plans in the United States. The

vast majority of these retirement plans are plans maintained by small businesses,

and today I would like to focus on the myriad of rules and regulations which continue to make it exceedingly difficult for small businesses to offer meaningful retirement plan coverage, particularly defined benefit plan coverage, to their employees.

As part of the Small Business Job Protection Act of 1996, Congress passed a number of pension simplification provisions intended to promote coverage under qualified retirement plans. ASPA supported these initiatives and applauds the efforts of

the members of this Committee in obtaining their passage. However, the enactment

of these changes was only a first step. Since the enactment of the Employee Retirement Income Security Act of 1974 (ERISA), the Congress has enacted layer upon

layer of complex laws, and the Internal Revenue Service (IRS) has issued layer upon

layer of complicated regulations seriously retarding the ability of small business to

maintain retirement plans for their employees. In most cases these rules were en-
69

1General Accounting Office, 401(k) Pension Plans—Many Take Advantage of Opportunity to

Ensure Adequate Retirement Income Table II.3 (August 1996). 2General Accounting Office, Private Pensions—Most Employers That Offer Pensions Use Defined Contribution Plans Table II.7 (October 1996).

acted not in the interest of promoting retirement savings, but to raise revenue and

to fund unrelated initiatives.

The effect of these costly rules and regulations on small business pension coverage

is both dramatic and rather disturbing. The facts speak for themselves. According

to a 1996 General Accounting Office study,1 a whopping 87 percent of workers employed by small businesses with fewer than 20 employees have absolutely no retirement plan coverage. It’s only slightly better for workers at small businesses with

between 20 and 100 employees, where 62 percent of the workers have no retirement

coverage. By contrast, 72 percent of workers at larger firms (over 500 employees)

have some form of retirement plan coverage.

This significant disparity is made even more troubling by the fact that small business is creating the majority of new jobs in today’s economy. As big firms go through

corporate downsizing, many of the displaced workers find themselves working for

small businesses. In fact, according to the Small Business Administration, 75 percent of the new jobs in 1995 were created by small business. However, because of

the many impediments to small business retirement plan coverage, these workers

will often find themselves without a meaningful opportunity to save for retirement.

ROADBLOCKS TO SMALL BUSINESS RETIREMENT PLAN COVERAGE

1. Excessive Regulation

Simply put, more regulation means fewer pensions. There are close to 4,000

single-spaced pages of regulations affecting retirement plans. In one instance, there

are close to 200 pages of IRS regulations interpreting just one sentence in the Internal Revenue Code. The costs associated with interpreting and applying these regulations are enormous, particularly for small business because there are fewer workers

among which to spread the cost. For example, the average cost of administrative expenses for defined benefit plans is approximately $157 per participant.2 However,

the cost per participant for a small business defined benefit plan can often be twice

that amount. Given how few small businesses provide retirement plan coverage for

their workers, ASPA believes that steps should be taken to reduce the administrative costs that a small business faces when establishing a retirement plan.

2. Present-Law Bias Against Small Business Plans

Surprisingly, there are a number of present-law rules which work to discourage

small business from establishing retirement plans on behalf of workers. Many of

these rules grew from a bias that small business plans were only established by

wealthy professionals (e.g., doctors and lawyers) and that only the professional, and

not the staff, received any benefits under these plans. This is simply not the case

in today’s workforce. According to the Small Business Administration, less than 10%

of small firms today are in the legal and health services fields. Small business includes high technology, light industrial, and retail firms which have stepped into the

void created by the downsizing of big business. The same rules targeted at the doctors and lawyers also negatively affect these burgeoning small businesses. This is

unfair and impedes the ability of small business to compete with larger firms when

trying to attract employees.

The present-law funding limits, for defined benefit plans, are a prime example of

how overbroad legislation can have a disastrous effect on small business retirement

plan coverage. In 1987, the full funding limit—the limit on the amount an employer

is allowed to contribute to a defined benefit plan—was substantially reduced. The

changes were made solely to raise revenue and had nothing to do with retirement

policy. As an actuary, I can tell you that the current law full funding limit seriously

impairs the funded status of defined benefit plans and threatens retirement security

because it does not allow an employer to more evenly and accurately fund for projected plan liabilities. One way to conceptualize the problem is to compare a balloon

mortgage to a more traditional mortgage which is amortized over the term of the

loan. The full funding limit causes plan funding to work more like a balloon mortgage by pushing back necessary funding to later years. This is particularly harsh

on small business because a small business does not have the cash reserves and resources that a large firm has, and so would be better off if it could more evenly fund

the plan. Even worse for small business, a special rule in the Internal Revenue Code

relaxes the full funding limit somewhat but only for larger plans (plans with at least
70

3 U.S. Department of Labor, Private Pension Plan Bulletin—Abstract of 1993 Form 5500 Annual Reports Table F2 (Winter 1997). 4The Advisory Council on Social Security also urged in its recently issued report that the full

funding limit be modified to allow better funding of private pension plans. Report of the 1994–

1996 Advisory Council on Social Security, Volume I: Findings and Recommendations 23 (January 1997).

100 participants). Once again this appears to be a vestige of the view that small

business plans are just for doctors and lawyers.

Small business owners are aware of the present-law funding limits on defined

benefit plans, and that is why small businesses with defined benefit plans are trying

to get rid of them and new small businesses are not establishing them. From 1987,

when the full funding limit was changed, to 1993—a period which saw a significant

increase in the number of small businesses established—the number of small businesses with defined benefit plans dropped from 139,644 to 64,937.3 That is over a

50 percent decline in just seven years. To reverse this trend, ASPA strongly believes

that the full funding limit should be repealed to allow for more secure funding.4

3. Unreasonable PBGC Insurance Premiums on New Defined Benefit Plans

Imagine if you had to pay premiums on a life insurance policy based on a

$100,000 benefit, but that the policy only paid a $50,000 benefit. No sensible consumer would purchase such a policy. However, that is in fact what often occurs

when a small business adopts a new defined benefit plan.

Let me explain. If a newly created defined benefit plan gives credit to employees

for years of service prior to adoption of the plan, the tax code funding rules limit,

in the early years of the plan, how much can be contributed to the plan to fund

the benefits associated with this past service credit. Consequently, the new plan is

treated as ‘‘underfunded’’ for PBGC premium purposes and the plan is subject to

a special additional premium charged to underfunded plans. This premium is assessed even though the premium is based on benefits which exceed the amount the

PBGC would pay out if they had to take over the plan. In other words, the small

business is forced to pay premiums to insure benefits that exceed what the PBGC

will guarantee.

This additional premium can amount to thousands of dollars and is a tremendous

impediment to the formation of small business defined benefit plans. Given the

pressing need to expand pension coverage for small business employees, particularly

defined benefit plan coverage, ASPA strongly suggests that this Committee and the

PBGC consider ways to reduce this unnecessary burden on new small business defined benefit plans.

INADEQUACY OF DEFINED CONTRIBUTION PLAN BENEFITS

In the typical lifespan of a small business, it generally takes a number of years

before a small business has the resources to establish a retirement plan. In my experience this does not usually occur until the small business owner is in his or her

mid-40s and most likely both the owner and the workers have not previously been

covered under a retirement plan. Consequently, they are getting a late start on their

retirement savings, and a defined contribution plan—like the SIMPLE plan—may

not offer enough savings to produce an adequate retirement income.

Here is a straightforward example. Assume a small business adopts the SIMPLE

plan. One of the workers who has been with the small business for 10 years is 45

years old when the SIMPLE plan is adopted and currently earns $40,000 annually.

If this worker and his or her employer contribute 10 percent of pay annually to the

plan until retirement at age 65, and the plan’s investment return is 7 percent per

year, the worker can expect to retire with an annual pension of approximately

$18,000, only about 45 percent of his salary. Most retirement planning professionals

will tell you that a retirement income replacement ratio of between 60 to 70 percent

of final average salary is a good rule of thumb when determining whether a retirement benefit is adequate.

But what about inflation? If this worker receives an annual salary adjustment of

4 percent per year and continues to contribute 10 percent of pay to the SIMPLE

plan, the worker will only accumulate enough money to fund an annual pension

benefit equal to 32 percent of final salary. By contrast, defined benefit plans can

provide greater benefits at no greater cost to the employer. How? By anticipating

salary increases in the plan’s funding assumptions, the employer contributes more

dollars to the plan in the early funding years. Because of this, more investment

earnings are realized by the plan, and better benefits can be delivered to the employee.
71

Despite the success of the SIMPLE plan, retirement plan coverage for small business workers continues to be inadequate because of the limitations on contributions

to the SIMPLE plan. The administrative burdens and high costs associated with

other qualified retirement plans providing greater benefits make it extremely difficult for small business to maintain such plans. In addition, small business workers

who are baby boomers and who have not previously been covered under retirement

plans will not be able to save enough under the SIMPLE plan or a 401(k) plan to

provide an adequate retirement income. ASPA believes small business needs a safe

harbor defined benefit retirement plan to complement the SIMPLE plan which is

easy to administer and which will provide small business employees, including baby

boomers, a sufficient retirement benefit.

SECURE ASSETS FOR EMPLOYEES (‘‘SAFE’’) PLAN ACT OF 1997

I congratulate the chair of this Committee for introducing a simplified defined

benefit plan which addresses these needs. The Secure Assets for Employees (SAFE)

Plan Act of 1997, introduced by Reps. Nancy Johnson (R–Conn.), Earl Pomeroy (D–

N.D.), and Harris Fawell (R–Ill.), creates a new safe harbor defined benefit retirement plan for small business which will provide all small business employees with

a secure, fully portable, defined retirement benefit they can count on without choking small business with complex rules and regulations small business cannot afford.

Here are some details:

1. Fully Funded and Secure Retirement Benefit

• SAFE plan retirement benefits will be totally secure because they will be funded either through an individual retirement annuity (‘‘SAFE Annuity’’) issued by regulated financial institutions or through a trust (‘‘SAFE Trust’’) whose investments

will be restricted to registered investment securities or insurance company products.

• SAFE plans will always have to be fully funded. The full cost of an employee’s

minimum defined benefit for each year of service is contributed to the SAFE plan

by the employer when earned. Each employee will have an account—either with a

SAFE Annuity or in the SAFE Trust—where plan assets will be held, and each year

the employee will get an account statement, issued by the trustee, indicating the

cash balance in the account and what the monthly benefit will be upon retirement

(age 65).

• SAFE plans will be required to use specified conservative actuarial assumptions

(e.g. a 5% interest rate assumption) to ensure the minimum retirement benefit. In

the unusual circumstance where actual investment returns do not meet the conservative actuarial expectations, the employer (utilizing the SAFE Trust) will have to

make a current contribution so that there are enough assets in each employee’s account to fund the minimum defined benefit. With the SAFE Annuity, since the financial institution guarantees the minimum benefit, no such employer contribution

would be required.

2. Minimum Defined Benefit With Possible Higher Benefit

• SAFE plans utilize the best features of both defined benefit and defined contribution plans by providing a fully funded minimum defined benefit, plus a higher

benefit if investment returns exceed conservative expectations. With the SAFE Annuity, this is achieved by using individual participating deferred annuities which

would have to guarantee the minimum defined benefit but also would have to give

some opportunity for a higher benefit based on investment performance. In the case

of a SAFE Trust, if the average return of the assets in the employee’s account exceed the required conservative interest rate assumption (5%), the employee will receive a higher benefit.

• At a minimum, employees will receive a benefit equal to 1%, 2%, or 3% of compensation for each year of service. For example, if an employee whose average salary was $40,000 has 25 years of service for an employer who elects a 3% benefit,

the employee will retire with a minimum $30,000 annual benefit (which could be

higher depending on investment performance). If the small business runs into financial difficulty in any year, it can elect to reduce the minimum benefit to 2% or 1%,

or even zero. The percentage benefit in any year must be the same for all employees.

• In order to allow baby boomers to catch-up with their retirement savings, employers can elect to credit benefits for up to 10 prior years of service, provided such

benefits are credited to all employees eligible when the plan is adopted and the prior

service is funded over an equal number of years (e.g., funded over 5 years if the

employee has 5 years of prior service). The full cost of the benefit for each year of

prior service is funded at the same time as the benefit for the current year of serv-
72

ice. Prior service could not be granted for prior years when the employee was covered under another defined benefit plan. • An employee’s benefit is 100% vested at all times.

3. Fully Portable Retirement Benefit

• Employees participating in the SAFE Annuity who separate from service automatically hold an individual retirement annuity that will pay them at least the benefits they have earned (and possibly a higher benefit) upon retirement. They can

even choose to continue to fund the annuity themselves, and thus increase their retirement benefit, in accordance with current-law Individual Retirement Account

(‘‘IRA’’) rules. • Employees participating in the SAFE Trust will have their retirement benefits

automatically converted to a SAFE Annuity, or, if they elect, have the cash balance

in their account transferred to an individual retirement account (a ‘‘regular IRA’’).

Either can continue to be funded under current-law rules.

• The benefit in a SAFE Annuity may be rolled over to another SAFE Annuity

without restriction. However, in order to ensure adequate benefits for retirement,

benefits in a SAFE Annuity and SAFE Trust will be subject to substantial early distribution restrictions.

4. Easier to Administer

• SAFE plans will have simplified reporting requirements, including a simplified

actuarial report verifying that the employer satisfied the annual funding requirement.

• SAFE plans will not be subject to complicated nondiscrimination rules or plan

limitations. However, so that plan benefits are distributed fairly to all employees,

SAFE plans, like SIMPLE plans, will be subject to the current-law annual limit on

employee compensation ($160,000).

• Since SAFE plans are always fully funded using conservative actuarial assumptions, Pension Benefit Guarantee Corporation (‘‘PBGC’’) insurance premiums are not

required.

5. Complements the SIMPLE Plan

• SAFE plans can be used with SIMPLE plans or 401(k) plans. However, no other

defined benefit pension plans can be maintained if an employer maintains a SAFE

plan.

• Employer eligibility, employee eligibility, and the definition of compensation are

the same under the SAFE plan as under the SIMPLE plan.

• As with SIMPLE, employers using a SAFE Annuity can designate a financial

institution.

SECURE MONEY ANNUITY OR RETIREMENT TRUST (‘‘SMART’’) PLAN PROPOSAL

I also congratulate the Clinton administration for supporting the expansion of

small business defined benefit plan coverage by proposing the SMART plan. The

SMART plan, which is heavily based on the SAFE plan proposal, is also a simplified

defined benefit plan.

Although there are more commonalities than differences between SAFE and

SMART, there are some important distinctions. These differences could have a serious impact on the attractiveness of a simplified defined benefit plan to small businesses. ASPA certainly believes that any simplified defined benefit plan developed

by Congress must be one that will be embraced by small businesses.

Following are some of ASPA’s views regarding the more significant differences between SAFE and SMART:

1. PBGC Insurance Premiums

As indicated previously, given the fully funded nature of the SAFE plan, the

SAFE plan does not require small businesses to pay PBGC insurance premiums.

The SMART plan proposal, however, would require the payment of ‘‘reduced PBGC

premiums,’’ although the exact amount has not been specified by the Clinton administration.

ASPA believes that given the design of the SAFE plan, which must always be

fully funded with specified conservative actuarial assumptions, the risk of loss to

participants is extraordinarily small. Nevertheless, a reduced PBGC premium might

enhance the marketability of the plan to small business since benefits would be protected even in the small likelihood of a loss to participants on plan termination.

Consequently, ASPA would not have an objection if either SAFE or SMART (in the

qualified plan form) required PBGC insurance premiums, provided such premiums
73

recognize the greatly reduced insurance risk to the PBGC and are substantially less

than the current premium of $19 per participant.

2. Conversion of Participant’s Account Balance to Individual Annuity at Retirement

Under the SAFE plan proposal, benefits at retirement age (i.e., age 65) are based

upon the amount in the employee’s account. The employee can elect a lump sum

or annuity purchased with the balance in the employee’s account. Given the conservative actuarial assumptions, in most cases the employee should receive a benefit

higher than the benefit under the plan, whether in the form of a lump sum or annuity. However, in certain circumstances, if the employee elects to receive benefits in

the form of an annuity, it is possible the amount in the employee’s account will be

insufficient to purchase an annuity providing the employee’s specified benefit. This

is because the market for purchasing annuity contracts on an individual basis is extremely inefficient. Because small businesses have minimal purchasing power, it is

often impossible to find an insurer willing to sell a competitively priced individual

annuity contract. For example, as the ACLI will testify, it is unlikely an insurer

would offer an annuity with a 5% rate of return. It is more likely that a lower rate

of return would be available, which raises the cost of the annuity.

In practice, this issue generally will not cause problems for the following reasons:

a) most employees will elect to receive their benefits in a lump sum rolled over into

an IRA; and b) excess earnings allocated to an employee’s account should offset the

higher annuity costs.

Nevertheless, the remote possibility does exist that the employee’s account will

not have enough to purchase the promised annuity. The SMART plan proposal addresses this by requiring the owner to contribute extra money to the employee’s account at retirement, above the annual funding requirement, to pay for any shortfall

that may exist should the employee elect an annuity. With SAFE, I understand that

it was decided not to do this because there was concern small business owners

would be discouraged from adopting the plan if faced with this possible additional

liability.

The PBGC, in its testimony, emphasizes this distinction between SMART and

SAFE. They characterize the issue by stating that ‘‘SMART is a true DB plan,’’ and

implying that SAFE is not. While ASPA strongly disagrees with this characterization, ASPA does agree that it would be preferable if participants could elect to receive an annuity paying the full amount of their specified benefit in every instance.

Consequently, ASPA would not object if the approach used in the SMART plan proposal to address this issue was incorporated into the SAFE plan. However, given

the difficulties described earlier that small plan sponsors have when purchasing individual annuity contacts, ASPA strongly suggests that this Committee consider the

proposal described in ACLI’s testimony to allow the sponsor of the SAFE plan to

select from a range of interest rates from 3% to 5% upon adoption of the plan. This

will allow the SAFE plan to be funded at levels that more closely resemble the individual annuity market.

In addition, we would suggest that the PBGC be given authority to develop methods for small business owners to purchase individual annuities on a more competitive basis. For example, the PBGC could facilitate negotiating master contracts with

insurance companies which could be used by small business owners sponsoring a

SAFE plan.

3. Employer Eligibility

Like SIMPLE plans, SAFE plans can be adopted by employers with 100 employees or less. The SMART plan proposal uses the same approach, except professional

service employers are excluded and a SMART plan may not be adopted if the employer maintained another defined benefit plan within the last five years. ASPA

strongly disagrees with these limitations.

There is no sensible tax policy that justifies excluding professionals from eligibility. If the concern is potential abuse, the SAFE plan has built-in design features

like caps on the available benefit formulas and limits on the amount of annual compensation (i.e., $160,000) that are taken into account which prevent such abuse. The

fact is, some non-professionals, like skilled tradesman, often make more than socalled professionals in today’s workforce. As long as everyone is on a level playing

field in terms of plan design, a group of employers should not be excluded simply

based on what business they are in.

Similarly, a small business should not be punished for previously offering a defined benefit plan. The SMART plan proposal does this by not allowing adoption of

the SMART plan if the employer had a defined benefit plan in the last five years.

If the Clinton Administration is concerned about individuals doubling up on benefits, ASPA believes the approach taken by the SAFE plan is the better approach.
74

Under the SAFE plan, employees are not allowed prior service credit for years they

were previously covered under a defined benefit plan.

4. Past Service Credit

One of the chief policy goals of the SAFE plan proposal is to allow small business

employees who have not previously been able to save sufficiently for retirement to

catch-up with respect to their retirement savings. Defined benefit plans are ideally

suited for this because they can provide benefits to employees for years of service

prior to adoption of the plan. The SAFE plan accomplishes this by allowing a small

business to give current employees up to 10 years of past service credit. To encourage the small business to maintain the plan, such past service credit would have

to be funded over an equal number of years (e.g., 5 years of past service would have

to be funded over 5 years).

Unlike traditional defined benefit plans and the SAFE plan, the SMART plan

does not allow for any past service credit. In ASPA’s view, small businesses will

simply not adopt the SMART plan unless it allows small business employees to

catch-up with respect to their retirement savings. The SMART plan attempts to

compensate for the lack of past service credit by allowing for an additional 1% benefit during the first five years of the plan. However, this is completely inadequate

since it does not allow the small business to reward existing employees who have

contributed to the development of the small business prior to adoption of the plan.

5. Compensation Limit

The annual limit on compensation that may be taken into account for benefit purposes under the SAFE plan is $160,000 (indexed). This is the same limit in current

law that applies to SIMPLE plans and all other qualified retirement plans.

Under the SMART plan, the proposed annual compensation limit is $100,000.

ASPA strongly believes there is no justifiable policy reason for imposing a special

lower compensation limit. Because it is a defined benefit plan, benefits provided to

lower-paid workers under both the SAFE and SMART plans are significant and substantially greater than what is provided under the SIMPLE plan. The owners of

small businesses need an incentive to provide these greater benefits to lower-paid

workers. However, the compensation limit will potentially reduce the small business

owners’ benefits. Simply put, given the significantly greater benefits for lower paid

workers under both SAFE and SMART, lowering the compensation limit is going

in the wrong direction and the compensation limit under SMART should at least

be the same as under SIMPLE and current law.

CONCLUSION

As early as President Carter’s Commission on Pension Policy in 1981, there has

been recognition of the need for a cohesive and coherent retirement income policy.

ASPA believes there is a looming retirement income crisis with the convergence of

the Social Security trust fund’s potential exhaustion and the World War II baby

boomers reaching retirement age. Without a thriving pension system, there will be

insufficient resources to provide adequate retirement income for future generations.

In particular, four elements have converged to create this crisis:

• The baby boomer population bubble is moving inexorably toward retirement

age.

• Private savings in the United States has declined dramatically.

• Most employees, particularly small business employees, continue not to be covered by qualified retirement plans.

• In the absence of major changes, our Social Security system is headed for bankruptcy.

During the years 2011 through 2030, the largest ever group of Americans will

reach retirement age. Without a change in policy or practice, many of this group

will find themselves without the resources to be financially secure in retirement.

Most pension practitioners will tell you that the constantly changing regulatory environment has created more complexity than most employers are willing to bear;

consequently, coverage under qualified retirement plans has dropped. The problem

has affected small businesses most severely—they have less resources to pay the

compliance costs and must spread those costs over fewer employees. During the

early decades of the next century, the ratio of workers to retirees will be significantly lower than it is today. The shrinking ratio of workers who pay Social Security

to those drawing benefits makes it likely that future retirees will have to rely more

on individual savings and private pension plans and less on Social Security. A

generational economic conflict is inevitable unless immediate action is taken.
75

We believe there is need for constructive pension reform, particularly with respect

to small business retirement plan coverage. We believe that the time has come to

enact comprehensive legislation which will provide an opportunity for all working

Americans to obtain financial security at retirement.

Mrs. J

It’s a pleasure to welcome you, Mr. Fradette from Bristol, ConOHNSON of Connecticut. Thank you very much.

f

necticut, to today’s hearings. I’m glad you were able to make it.

STATEMENT OF GREG FRADETTE, SR., GREG FRADETTE

AGENCY, INC., BRISTOL, CONNECTICUT

Mr. FRADETTE. Thank you, Madam Chairman. Thank you for inviting me to testify before your Subcommittee today. I appreciate

this opportunity to explain why current pension laws have made it

difficult for me to offer complete retirement for my employees.

My name is Gregory Fradette and I am owner and founder of the

Greg Fradette Agency—a 10-year-old insurance agency located in

Bristol, Connecticut. I currently employ 13 people—many of whom

have been with me for a number of years. The Greg Fradette Agency sells a wide variety of insurance products. Business customers

represent approximately 85 percent of our client base. And as you

are well aware, Madam Chairwoman, Connecticut is home to many

small manufacturers. These manufacturing companies represent

the backbone of our agency, accounting for half of our business.

Although we are a small business, I am proud of the level of benefits that we offer our employees. Comprehensive health insurance,

including prescription drugs and dental coverage, life insurance,

short-term disability income, paid vacation, flextime and a matching 401(k) plan are all part of the standard benefit package of the

Fradette Agency. In addition, our agency has had five babies in the

last 10 years. We’re happy to say that we were able to accommodate our young working mothers with a flexible work schedule. All

of our soon-to-be soccer moms are back to work full time. Thanks

in large part to the efforts of our employees, business is good.

I’d like to expand the retirement package to include a traditional

defined benefit pension plan. Currently, participants in our 3-yearold 401(k) plan can contribute up to 3 percent of salary, and we

will match that by 50 percent. While I am pleased with the success

of the 401(k) plan so far, I recognize that this will not generate a

sufficient amount of retirement income for either myself or my

older employees. That is why I am researching the feasibility of establishing a defined benefit pension plan.

However, I am told that the complex regulations of current pension law would make it very costly for me to establish a plan that

would provide a more adequate retirement income for my employees. Large employers can spread these administrative costs over a

large number of employees. I don’t have that luxury. Establishing

a traditional pension plan is cost-prohibitive for me at this time.

That is why I support your SAFE plan proposal, which will allow

me to adapt a small business defined benefit plan with significantly

reduced administrative costs.

I am blessed with dedicated, hardworking employees, and I

would like to provide an affordable pension plan for them, but in
76

order for me to do so, the laws need to make it possible for small

employers like me to establish such affordable plans.

On a personal note, Madam Chairwoman, from 1986 to 1994, my

wife and I paid to send our three children through college. We’re

proud of the fact that all three graduated. But college tuition, along

with the startup costs of my agency, used up all our savings. Now,

at age 50, I have to start saving for our retirement. So please enact

the SAFE plan proposal as soon as possible, so that my employees

and I can start saving adequately for our retirement.

And thank you again for the opportunity to testify today, Madam

Chairwoman.

[The prepared statement follows:]

Statement of Greg Fradette, Sr., Greg Fradette Agency, Inc., Bristol,

Connecticut

Madame Chairman, thank you for inviting me testify before your subcommittee

today. I appreciate this opportunity to explain why current pension laws have made

it more difficult for me to offer complete retirement benefits to my employees.

I am owner and founder of the Greg Fradette Agency, a 10 year old insurance

agency located in Bristol, Connecticut. I currently employ 13 people, many of whom

have worked for me for years. The Fradette Agency sells a wide variety of insurance

products, about 85% of which is to commercial customers. As you know, madame

chairman, northwest Connecticut is home to many small manufacturing companies.

My agency has a close working relationship with many of these companies, who represent over half of my overall business.

As a small business owner, one thing I am proud of is the level of benefits I offer

my employees. Comprehensive health insurance, life insurance, paid vacation, profit

sharing, and a 401(k) plan with employer matching contributions are all part of the

standard benefits package at the Fradette Agency.

However, now that my business has become more established, I am in the position

to expand the retirement package that the company offers to include a traditional

defined benefit pension plan. Currently, participants in our three-year-old 401(k)

plan can contribute up to three percent of salary, which is then matched fifty cents

on the dollar by the company. Over two-thirds of my employees participate.

While I am pleased with the operation and success of our 401(k) plan so far, I

recognize that this will not generate a sufficient amount of retirement income for

either myself or any of my older employees. Therefore, I am researching the possibility of establishing a defined benefit pension plan. However, I am told that under

current law, complex regulations make it not very cost-effective for me to establish

such a plan which will provide a more sufficient retirement income for my employees. Because I can spread the administrative costs over fewer employees as compared to a large employer, setting up a traditional pension plan is cost-prohibitive

for me at this time. That is why I support your SAFE plan proposal which will allow

me to adopt a small business defined benefit plan with significantly reduced administrative costs.

I am fortunate to have dedicated, competent employees working for me, and I

want to be able to provide this benefit to them. But in order for me to do so, the

laws need to make it possible for small businesses to establish plans in a costeffective way. Please enact the SAFE plan proposal as soon as possible so that baby

boomers like me and my employees can save adequately for retirement.

Thank you for the opportunity to testify today, madame chairman.

Mrs. J

I apologize to those members of the panel whose testimony I was

OHNSON of Connecticut. Thank you very much.

f

unable to hear, but also to Mr. Strauss, and I thank my colleague,

Mr. Portman, for starting this hearing.

You may have read in the newspapers of the terrible incident in

Connecticut where four State employees were killed by an angered

member of their group, and I mention that because people who

serve in government are important to all of us. A good functioning
77

government is essential to a free society, and some of those who do

serve, our citizens, do often run a lot of risk from the public they

deal with, but also in the constraining governance of employee

problems that we all live with. And so it was my not only obligation, but personal responsibility to be at the funeral of my friend

and compatriot, Linda Laganowski, former mayor of New Britain,

my hometown, who was one of those, but also to take part with the

Governor in recognizing the service of these individuals to our

State and the tragedy of their death. They were all extraordinary

people. It was tragic to read of their lives left behind—spouses,

children, volunteers in their community, coaches of little league, all

the things that we know make a difference in building our communities and assuring the strong families that we know are the heart

and soul of a free society.

So I’m sorry that I had to be late, and I appreciate the help of

my colleague, Mr. Portman, and the indulgence of all of you.

I would like to, first of all, commend you, Ms. Shaffer, on the

pamphlet, ‘‘On Women’s Retirement.’’ I did have a conference on

women and investing recently, had a very small turnout, but it was

really interesting some of the people who came. Women are beginning to realize that they have a responsibility to plan for their own

retirement, whether they’re single or whether they’re married.

I also appreciate some of the comments that those who testified

made in regard to the differences between SAFE and SMART, and

I want to concentrate my questions on two aspects of the differences between SAFE and SMART, and then throw out one other

question.

First of all, SAFE allows 1 to 3 percent, a program that would

provide 1 to 30 percent of income to be saved each year. The

SMART program is less generous, both in threshold of $100,000

and in the use of the 3 percent. When you look at the calculations

from each plan, neither plan is talking about more than, say, about

30,000 a year or 22,000 a year, I think is what most of them are.

Now 22,000 a year with a relatively low Social Security benefit is

not a lot, looking to the future. So it seemed to me unwise to limit

the 3 percent option as it is limited in SMART. That’s one issue

I’d like to hear your thoughts on.

Second, I was very interested, Mike, that you think the pension

guarantee benefit premium is a good idea. I’d like to hear other

people’s thoughts on that, but it seems to me unnecessary to ensure a fully funded plan.

And then, last, on the issue of spousal consent, that has become

kind of a two-edged sword. I have an employer who came to me

just last week saying that he must have these spousal consent

forms because they’re making changes in their plans, but now some

of the families that are having difficulty don’t want to get them.

And these are women who don’t want to deal with their spouse

about this, for a variety of possible reasons. So that is an issue.

Incidentally, I also want to acknowledge my colleague and friend,

Earl Pommeroy, who is with us, and will have a chance to question

after the Subcommittee Members do so.

So if you could comment on the 3 percent issue, the pension benefit guarantee fund premium, for those of you who didn’t comment

on that, and the issue of spousal consent. Is it time that we begin
78

to look at that differently? Maybe if your other spouse has a pension at his place of his business that comes out of his wages or his

determination—you know, how do we begin to look at spousal contributions now in the sense of ownership that I see in lots of

women in all ages of their benefits, sort of in the new world?

When we got that spousal consent—and I remember sitting at

the White House when Reagan was President, and we, on a bipartisan basis, got this change in the law, it was primarily because

women weren’t working; men were the ones who were working, and

whether or not their husbands’ pension planned allowed or assured

that choice was a very, very important issue. When both people are

working and have different options for retirement benefits, we need

communication and agreement perhaps, but do we see the spousal

benefit exactly the same way for the next 50 years that we saw it,

say, 10 years ago?

Ms. SHAFFER. Well, obviously, it’s a very complex issue, and it is

true that working women now are more present in the work force

than ever before. But when you cite the average pay equity statistics for women in the work force, which have been compounded in

retirement to create a retirement gender gap, I would think that

at this point in time, for the average woman, we would want to err

on the side of disclosure and spousal options. Because those

women, in general—and there are, obviously, exceptions—are still

going to be earning less than their male spouse, are going to have

given up years in the work force for care giving responsibilities.

This formula will affect their retirement benefits, as well as, their

Social Security benefits—all three legs of that retirement planning

stool, and, in general, those factors would still create a real disadvantage for women not having choices, not having participation

in those choices, because they are going to likely earn less than

their husband.

So to the extent that women and their families are dependent on

these options, we need, I think, at this point to preserve them. Obviously, as time goes on, if the pay gap erodes to the point where

we have more parity, more equity, perhaps this will be less of an

issue, but these factors for working women truly exacerbate their

vulnerability in retirement.

And, incidentally, some of those poverty statistics that I quoted,

comparing particularly single women in retirement and single men

in retirement, for example—I shortened my remarks because of the

time constraints, but there’s a chart showing that the United

States of America has a higher rate of single women living in poverty than any of the industrialized nations. That truly gives one

cause for concern and kind of puts that in perspective. Hopefully,

there will be a point in time where maybe those issues should be

revisited, but I think we need to err on the side of spouses having

an opportunity to participate in the decision—and certainly in divorce situations, spouses knowing before divorce agreements are finalized—what rights and options they may have to exercise.

I also wanted to correct one impression. I cited this pamphlet,

but it is not a BPW publication. It is a project of WISER, Women’s

Institute for a Secure Retirement, and the Heinz Foundation. We

are helping to distribute it to all our members across the country,

and we commend WISER for producing this.
79

Thank you.

Mrs. JOHNSON of Connecticut. Thank you. Anyone else want to

comment on the other issues?

Mr. LEONARD. I would like to comment on that, too. Enforcing

what Gail said, my wife works full time; I work full time. I make

70 percent of the income; she makes 30 percent. So if she did not

have the opportunity to investigate pensions and have spousal consent, she would be in the same type of trouble that Gail mentioned.

Mr. CALLAHAN. At PenTec, Madam Chairwoman, we probably

process somewhere close to 4,000 to 5,000 distributions annually,

and though there’s an administrative cost or burden that’s associated with that, we don’t really see very many problems with getting those spousal signatures. I think in terms of looking at those

spousal signatures and ensuring that there’s a knowledgeable decision that’s made, it certainly relieves the employer of some fiduciary responsibilities, and it’s knowledge that’s being gained by

having those spousal signatures. So I agree with Ms. Shaffer. I

think it’s not time yet.

Mrs. JOHNSON of Connecticut. What about the issue of the 3 percent option?

Mr. MEROLLI. I’d be happy to comment on that. I don’t feel, quite

honestly, that the 2 percent is sufficient. The SMART minimum defined benefit is either 1 or 2 percent, and it increases to 3 only during the first 5 years of participation. SAFE is 1, 2, or 3 percent,

and you can use 10 years of past service as well.

If you’re a gentleman like Mr. Fradette, and your children have

gone through college, you’re 50 years old now, and you want a simple way to save a lot of money in a short period of time. I think

taking into account the fact that you can go up to 3 percent benefit

times years of service and use up the 10 years of past service

means that you can catch and you can fund an adequate benefit

for your own retirement now that you have put your children

through school. I think $160,000 compensation limit also ties in

with that, and I think it’s much more beneficial and much easier

to handle than $100,000 cap.

We deal with small plans all the time. We have 1,400 plans that

we act as third-party administrator for. Our defined benefit total

has shrunk to less than 100, and a lot of those folks, like Mr.

Fradette, are right now, if they want something simple, they have

to stay with defined contribution. I think with using SAFE, with

10 years of past service and a 3 percent annual rate of accrual is

the way to go.

Mrs. JOHNSON of Connecticut. Thank you. There’s a very, very

important point. This Subcommittee changed the pension laws in

regard to teachers last year, for exactly that reason. They have

buyback rights, but they were capped, and you can’t exercise your

buyback rights because you don’t have any money to buy back until

later in life, when your children have finished college, and then

they were limited as to how much they could buy back, even

though the buyback was absolutely legitimate, and something they

had earned.

So this one goes not necessarily to the pattern of women’s lives,

but to the pattern of our lives—men and women. There are years

when you have disposal income, and there are years when you
80

don’t. If we limit these pension plans so that you can never save

more than a rather minimal amount, then we limit retirement benefits as well. So that’s interesting.

Mr. Coyne, I’d like to yield to Mr. Coyne for questioning.

Mr. COYNE. Thank you, Madam Chairwoman.

Mr. Fradette, in your testimony you mentioned that two-thirds

of your employees are participating in the 401(k) plan. One of my

concerns is that the pension system that we’re currently under has

a lot of employees who are unwilling or unable to participate in

plans, 401(k) plans, just like some of your employees.

I wonder if you could tell us, not just in your company, but generally, who are the individuals that make up the one-third that

don’t participate? Are they people who are low-income workers or

short-term employees? Do you have any sense of that?

Mr. FREDETTE. Well, in our particular case, we’re dealing with

just 13 employees, and there are 2 or 3 who aren’t participating.

They’re fairly young, and at this particular point I think they’d just

as soon take all the income, and hopefully, as time goes on and

they become more secure in their job, they’ll see the light and participate in the 401(k), but that’s really what’s going on right now

at our agency.

Mr. COYNE. It’s the younger employees who maybe feel that they

don’t have the resources to be able to contribute——

Mr. FREDETTE. Exactly.

Mr. COYNE [continuing]. Into the 401(k) plan?

Thank you.

Mrs. JOHNSON of Connecticut. Mr. Portman.

Mr. PORTMAN. Thank you, Madam Chair. I have a lot of questions. I really appreciate all the expert testimony.

My first question is really a basic one, which is: Who’s going to

use this plan? How popular is it really going to be? We’ve heard

a lot of good testimony today about how the SAFE or SMART or

SMART/SAFE plan might be important. I talk to a lot of small

businesses who are interested in some kind of retirement savings

plan, but they’re not sure if they can get into a defined benefit

plan. They’re more interested in a SIMPLE type plan. And I wonder if any surveys have been done, if you all have talked, on an

informal basis with your plan participants? You said, Mr. Merolli,

I think you have over a thousand plans you work with; and, Mr.

Moore, you work with a lot of plans around the country. Is this

going to be something that will be popular?

Mr. MEROLLI. I think it will be very, very popular. We have a

lot of baby boomers, myself included, who have reached a point,

like Mr. Fradette, and they need to save a lot of money in a very,

very short period of time, and the complexities of present-day defined benefit law have basically shied them away from it, and I

think it’s going to be a very, very strong market. I feel better about

this than I did about SIMPLE, and SIMPLE’s been pretty good.

Mr. MOORE. I’d share that assessment. I think it will be attractive to the small employer and the small business employee.

And I wanted to tie in one point that was raised earlier about

the catchup provision of the 3 percent. I think this is another reason it’s attractive. If you’re a younger person, as was pointed out,

and maybe you’re not participating now, and you get to be 40 or
81

50, and you realize you should have been catching up. There might

be a tendency to make what would be riskier or high-risk investments.

Mr. PORTMAN. Yes.

Mr. MOORE. This provides a very equitable and safe mechanism

for you to catch up by recognizing past years of service. It’s a very

safe plan for all of us, and I think it’s a great opportunity for somebody to catch up in a fair manner.

Mr. PORTMAN. Mr. Callahan.

Mr. CALLAHAN. Congressman Portman, there are some rules of

thumb that I’m going to provide just as a general approach. If you

take a look at a person who’s about 20, 22 years old, a 2-percentof-pay-per-year contribution provides him adequate retirement income. When you get to 30, it jumps to about 6 percent of pay.

When you get to 40, it increases to close to 20 percent of pay. And

when you get into your fifties, you’re now looking at a program

that you cannot have under our current system. So that leaves us

with a real problem at retirement age because people just can’t accumulate enough.

In addition to that, people don’t really know what the conversion

is: How much do they need? The number here was somebody earning around $28,000 needs one-quarter of a million dollars to retire.

Most employees don’t understand that number. They think if they

have $50,000 or $60,000 that they’ve accumulated over their lifetime, that that’s going to last them for 20 years. It’s not enough.

It’s not even close to being enough.

So what we’re going to find is some generational gaps where people are just going to live longer than what they have available to

them, and it’s going to be a substantial curtailment in their lifestyle. This kind of program, which has a guaranteed benefit, a floor

benefit with an upside to it, provides that guaranteed minimum

benefit. People understand that. They know what their monthly

benefit is, and when added to Social Security and some personal

savings, can provide an adequate retirement income. That’s why

this is so important.

Mr. PORTMAN. I think those are adequate responses. I share

those. My question was in a way a devil’s advocate question. I

think it’s time for us to really fill a gap, a major gap, and part of

it is that young people think they’re going to live forever, as many

of us did, I’m sure, didn’t prepare, and when you get to be a baby

boomer, my age, over 40, you begin to realize you need to catch up

quickly, and it’s difficult to do so with a defined contribution plan.

With regard to the PBGC guarantee, I think, Mr. Merolli, you

had some strong views on that. It wasn’t necessary. Mr. Moore, I

think you thought it was important, which is, as you know, contained in the SMART plan, not the SAFE plan.

I guess one question I would ask for the panel, and maybe quickly those of you who are out in the business of marketing plans or

have been involved with companies that are looking for these kinds

of plans, Mr. Strauss made the point that he had talked to at

least—he mentioned one person in the business who said this was

going to be a great marketing tool because companies would be

much more likely to pick up a plan like SMART or SAFE if they
82

knew the Federal Government was behind it. Is that your experience? And how does that balance with the premium responsibility?

Who’d like to take a crack at it first? Mr. Moore, maybe first, and

then Mr. Merolli.

Mr. MOORE. I generally share Mr. Strauss’ assessment. I think

you have to look at it from the perspective of who’s going to be participating also. If there is a sense of security that the PBGC stands

beside that, then it’s going to be very easy for the employer, quote/

unquote, ‘‘sell his program.’’ So from that sense, marketability, yes,

absolutely.

Mr. PORTMAN. OK, Mr. Merolli.

Mr. MEROLLI. Up until now, PBGC premium, the requirement to

be in PBGC has not been a positive as far as a marketing standpoint because it’s added a lot of complexity. PBGC forms are pretty

extensive. And currently, professional service employers of under

25 employees are exempt from PBGC anyway. If you’re a small

business with just a couple of people and no rank-and-file workers

as well, you don’t have PBGC coverage currently, and that system

seemed to be working pretty well. If we wind up with PBGC coverage, though, it should be a really nice, simple, little form like one

little simple page with a really tiny, little premium.

I think it has in the past been an added expense. It’s discouraged

and it’s made defined benefit plans unaffordable for a lot of small

employers, particularly the ones we’ve been trying to hit at. That’s

been our experience.

Mr. PORTMAN. He told us today a number. It wasn’t in his testimony, but in his oral response he said five dollars. Is that a nice,

little, tiny amount?

Mr. MEROLLI. I would consider that a nice, little, tiny amount.

Mr. PORTMAN. Mr. Callahan.

Mr. CALLAHAN. I think we have to look at who’s our customer.

Our customer for these retirement benefits is a plan participant.

From the employer’s perspective, it’s a hidden tax, especially if

they have to make this as a fully funded benefit. From the customer’s point of view, from the plan participant, having that added

security of providing that minimum benefit, I think it’s important

issue.

So when we take a look at who’s the ultimate beneficiary of this

and who’s our ultimate customer, I see that——

Mr. PORTMAN. But the question is, who is the customer? Who’s

going to be making the decision to go into these plans? I guess in

many cases the employees are going to go to the employer and advocate for such a plan. So maybe, in a sense, they can be the indirect customer, but in most cases I would guess it’s the employer

making the decision.

Mr. CALLAHAN. I don’t think it’s an insurmountable barrier, but

as a hidden tax, it can be——

Mr. PORTMAN. How do you come out on the type of plans we’re

talking about here, the SAFE plan, for instance, do you think it

needs to have the PBGC guarantee?

Mr. CALLAHAN. I’m sorry, would you say that again.

Mr. PORTMAN. How do you come out on the issue?

Mr. CALLAHAN. I think it’s reasonable to have a PBGC-backed

guarantee as long as——
83

Mr. PORTMAN. You would prefer to have one?

Mr. CALLAHAN. If it’s small. If the guarantee is for the full benefit, the remaining full benefit, and the premium is small, then, yes.

If it’s the current guaranteed benefit premiums, I don’t think that

offers.

Mr. PORTMAN. OK. Thank you. Thank you for your help today.

Mrs. JOHNSON of Connecticut. Mr. Kleczka.

Mr. English.

Mr. ENGLISH. Thank you, Madam Chair.

This, it seems to me, is a very important topic, and we appreciate

a panel of this distinction being here to explore it. What we have

learned is that, increasingly, the experience of employees is going

to be a little different than it has been in the past. More and more,

people will be going to different employers during the course of

their career, and it’s estimated in the next century that it’s going

to be relatively common for someone to have five or six different

employers during their lifetime.

So I wanted to focus a little bit on portability. In your view, can

the law be improved to give participants in defined benefit plans

the same portability features as the participants in defined contribution plans? Who would like to comment on that? Mr. Leonard?

Mr. LEONARD. Yes, thank you very much. The IEEE has been advocating pension portability since about 1974. I think the SAFE

plan, as you’re proposing it, is an excellent way to provide portability to small companies. Our engineers are looking at the same

thing you mentioned—seven or eight job changes throughout their

entire career. The engineer that goes to work for one company and

stays there until he retires is gone. Maybe I’m the last one, but

there aren’t many left. Even some engineers are starting their own

consulting firms right out of school.

So, for small companies, a SAFE plans is what we need. For

large companies, an ability to transfer their pension from one company to another company by possibly Trustee to Trustee transfer,

maybe be a method of examining pension portability or defined

benefit plans for large companies.

Mr. ENGLISH. Mr. Leonard, how does your organization feel

about, putting the SAFE and SMART proposals side by side, how

do you feel about the $100,000 limit specifically that’s built into the

SMART plan?

Mr. LEONARD. I’d say I don’t like it. I’m more for the $160,000

limit. And if I might comment further, we are for the SAFE plan.

The SMART plan has a clause in it that excludes our type of professionals working as service employees. So IEEE would be for the

SAFE plan.

Mr. ENGLISH. I’d open this up to the other panelists, on how you

feel specifically on the portability end, how the SAFE and SMART

proposals stack up against each other, and what features you’re

particularly attracted to in either?

Mr. Merolli.

Mr. MEROLLI. Yes. Thank you. The beauty about the SAFE plan

is that each participant’s benefit, unlike a traditional defined benefit plan, which is a pooled account, in SAFE each participant’s benefit is kept in their own separate account. So all the benefits are,

and should remain, totally portable. When the individual termi-
84

nates from employment, for example, either a SAFE annuity or the

SAFE trust can be transferred to a SAFE annuity or to a traditional IRA, for example, or the 20-percent penalty tax is paid. The

20-percent penalty tax, obviously, discourages people from taking

their distributions before retirement, and the SAFE is structured

this way, so that it becomes totally and fully portable. And that’s

the beauty we like about it, and that’s the advantage it has over

the traditional defined benefit plan.

Mr. ENGLISH. Any other comments from the panel?

Ms. SHAFFER. Well, I would reiterate, from the point of view of

BPW/USA, that one of the features we applaud in the SAFE plan

is the portability. As I indicated, women tend to stay in a particular job on average for a lesser period of time than their male counterparts. They sometimes don’t even vest in that job because of

that, which is unfortunate. The average woman worker will lose

during her career 11.5 years in the work force, most often because

of care giving needs, she has to leave the work force and then come

back again. So, certainly, both with the care giving absences from

the work force that are particularly imperative sometimes for

women, and the tendency on the average for them to change from

job to job more often, portability is a very, very important feature.

So we very much applaud that in the SAFE plan.

Mr. ENGLISH. Well, I would at this point, my time having expired, like to thank the panel, but also add, since I haven’t had the

opportunity to do so publicly before, I would like to thank the

Chair for sponsoring this hearing, which I think is one of the most

important that we have had, not only in the Subcommittee, but the

Committee as a whole.

I want to compliment you specifically, Madam Chair, on your

leadership on this issue and building a bipartisan coalition to focus

on some of these very difficult pension issues, and I want to compliment you very much for your effort in this area, and thank you

for the opportunity.

Mrs. JOHNSON of Connecticut. Well, thank you very much, Mr.

English. There has been a lot of interest among the Members of the

Subcommittee in this issue, and we’ve talked about it now for quite

a while, and this is the first of two hearings, out of which we hope

will come some substantial advancements in the opportunity for

people to create retirement security for themselves.

Mrs. Thurman.

Mrs. THURMAN. Thank you, Madam Chairwoman.

Mr. Moore, we’ve received a report actually from some of our colleagues—I’ve lost in it in the myriad of paper up here—but, anyway, that while we know that about half of the employees have

pensions. The other significant issue in there, though, is that

around 21 percent of them actually make maximum contributions

to this.

How do we change that culture of have fun now and wait for Social Security later, or maybe you’ll have enough later on in your

life? What do we do to look at this issue?

Mr. MOORE. I’m sorry, I think I might have missed part of your

question. Were you saying that they’re spending the moneys in

their——
85

Mrs. THURMAN. Well, even if they have a pension plan available

to them, in fact—only about 21 percent are actually contributing

their full amount that they could contribute anyway.

Mr. MOORE. I think that SAFE goes a long way toward helping

people not only focus on the importance of retirement, but making

it easy for them to do. The biggest problem I see is the fact that

we actually run across the converse problem, and we probably deal

with anywhere between 3,000 and 5,000 phone calls and letters a

year about problems with pensions. The biggest problem is that

they just don’t have money to set aside.

The problem you’re describing with us tends to be a very small

problem. I think people are very conscious of what their retirement

needs are. Unfortunately, there are a lot of other competing needs

that are much more immediate. Buying a house, any sort of child

needs sometimes arise, special circumstances, and those things

take precedence, and they are immediate, whereas retirement is

further down the road. It’s the classic case of robbing Peter to save

Paul, but in this instance you’re one and the same; you’re Peter

and Paul.

And the problem for us is, how do we get a structure that limits—and one of the nice things about SMART, there is a substantial distribution, early distribution, penalty, to let people say, stop,

wait a second, is this really important enough to jeopardize your

retirement future? And in those instances where it is you go ahead.

But I think the real fundamental problem is that it’s not a lack of

awareness of people’s parts here; it’s a lack of an ability to have

access money. They just don’t have it.

Mr. CALLAHAN. Mrs. Thurman, I provide enrollment meetings to

different companies. During the course of 1 year, I probably do 40

or 50 enrollment meetings personally to companies’ participants.

There are a couple of things that I find that people are just not

aware of. One, that there was supposed to be a three-legged stool

for retirement purposes in the United States: Social Security, an

employer plan, and their own contributions. That’s clearly not understood at all. They never knew that they were supposed to take

responsiblity for of their retirement income. No one really knew

who was supposed to take care of it, but they never knew that they

were responsible for one-third.

Second, most knew somebody at one time that might have had

a defined benefit pension plan, but those plans are all gone now,

and nobody really takes care of pensions anymore. People believe

they’ll figure it out and do what they have to do.

We often have the discussion about the fourth leg to our retirement stool in the United States, in our employee enrollment meetings. And that fourth leg is really supplementing your income

through continued working past retirement. So we now have, just

by its nature of our policy here, developed that fourth leg of continued working.

The shift over to the 401(k) plans is a clear indication to anyone

looking at policy issues that we have shifted the entire responsibility for retirements for our future generations over to the employees, and this is one of the first chances to shift it back.

Ms. SHAFFER. I would also like to add the comment that, if we

want to encourage that kind of incentive for saving—for example,
86

from the point of view of working women—we would be well advised to address the issue of pay inequity, and support the Fair

Pay Act and the equal pay provisions, because women have far less

disposable income to put into a savings plan, when the average

woman is making less than $23,000, and when she is making 74

percent of her male counterpart, for African-American women the

figure is 64 percent, and for Hispanic women the figure is 53 percent—53 cents compared to the dollar of her male counterpart. So

for these women to plan for retirement is a particular burden when

they are faced with the same pressures of inflation and family support but at a much lower level of compensation; we really need to

address those overall issues because they’re exacerbated when they

get extrapolated over a career of lifetime earnings at a lower rate

that is truly not equitable. That’s what’s making us the leader

worldwide of elderly women living in poverty, for example.

Mrs. THURMAN. Madam Chairwoman, if I could just ask another

real quick question here—Mr. Callahan, in your testimony, you

talk about the unreasonable PBGC insurance premiums. This is all

kind of new to me. So I’m just trying to learn this along with probably other people as well. You say that if they buy into this, that

it’s going to cost them a lot more. I was under the impression that

there was a set premium per employee. Help me here.

Mr. CALLAHAN. There’s a risk premium. There’s a set premium

per employee under the current rules of $19 per participant.

Mrs. THURMAN. Right.

Mr. CALLAHAN. But if a plan is under——

Mrs. THURMAN. Per year?

Mr. CALLAHAN. Per year. If a plan is underfunded, there’s an additional risk premium, and that risk premium can vary significantly. So you can have very, very significant risk premiums if your

plan is underfunded. So if they’ve promised benefits or if the assets

perform poorly, if they promise benefits they haven’t been funding,

that additional amount can be significant.

If you establish a plan today and you want to grant credit past

service, under existing rules, you’re going to be underfunded for

that past service that you’ve granted, and that’s why you set the

plan up today on a defined benefit basis. That’s going to cause a

risk premium; it’s going to be a barrier for you to start such a plan.

Mrs. THURMAN. Can you give me an idea of how much we’re talking about in this?

Mr. CALLAHAN. It could easily rise to $50 per participant.

Mrs. THURMAN. For a long period of time or just during the

catchup period or——

Mr. CALLAHAN. It could be—a business lifetime is really 3 years.

It’s certainly going to be over a period of 3 years. It’s usually been

lasting somewhere in the neighborhood of 4, 5, or 6 years. It’s continued to last. It doesn’t go away.

As those plans become funded, as those plans reach new levels,

and the interest rates go up a little bit, there will be a little bit

of arbitrage there that will help us out, but the premium is going

to be pretty substantial. You wouldn’t want to establish a

brandnew plan today with any past service grants. You’d really

have to think about that an awful lot, because if you did that with-
87

out having the ability to fund it on an ongoing basis, your PBGC

premiums would be pretty substantial.

Mrs. THURMAN. Well, Madam Chairwoman, I’ve got to tell you,

I’m probably going to walk away from this hearing today with more

questions than I care to come with, I’ve got to tell you. So, hopefully, with your testimony rose a lot of other questions about some

other things. If you get a chance, come by; I need to sit down and

talk to you. [Laughter.]

Mrs. JOHNSON of Connecticut. Thank you. I’m going to recognize

my colleague, Earl Pommeroy, who is one of the Congress’ real experts on the pension issue, and we welcome him to sitting in on

our Subcommittee, and we’re happy to have him question. After

that, we are going to recess. We have a vote on the journal and two

5-minute votes. So there will be about a 15-minute recess before we

hear from Mr. Scanlon, our last witness.

Mr. POMEROY. Madam Chair, I thank you very much for allowing

me to attend today and ask a question. I want to congratulate you

for cosponsoring the SAFE legislation, being the driving force behind promoting its passage on the Hill, and thank you for holding

this hearing.

Panel, this has been simply the best discussion about defined

benefit plans in small employers that I have heard as a Member

of Congress. I think that points out something. We really, as a Congress, haven’t dealt in any way with the shift from defined benefit

to defined contribution retirement plans, and the many consequences that it presents.

Mr. Moore, I would ask you, as spokesperson of the Pension

Rights Center, for the worker, do you think there is still much to

commend the defined benefit format, even though it is looking, especially in the small employer sector, like it’s a dinosaur about to

vanish from the face of the Earth?

Mr. MOORE. There is under the SAFE and some of the provisions

of the SMART proposal, and some of the provisions that are being

entertained on the Hill right now—I believe so. The ultimate thing

that any employee is looking for is security, and that’s something

that the defined benefit plans provide par excellence.

It’s also looking at employer contributions. If you don’t have

enough money to set aside for a plan, you know that someone is

setting it aside for you, and that’s a major plus of any sort of defined benefit plan, the employer contribution. So, yes, I believe that

defined benefit plans have much to offer. I believe, particularly the

way the SAFE and the SMART plans are, historically, the people

who have been omitted are the small business employees, and this

legislation targets them specifically. It gives them the opportunity

to join in the benefits that some other people at larger corporations

have. You look at the people who have some of the best pension

benefits in this country. Their working at large employers, like GE

or GEM, Monsanto, and now you’re giving them the opportunity to

get a crack at that, too. And I think it’s excellent legislation, and

I think it’s a great opportunity for those people to enjoy the benefits of defined benefits.

Mr. POMEROY. Thank you, Mr. Moore.

I think Mr. Fradette, in particular—am I pronouncing your name

correctly—is exhibit A in terms of what we’re after, a small em-
88

ployer with personal retirement needs, but also recognizing the retirement needs of your small business work force, wanting to bring

a defined benefit plan online, but not really able to under the existing lay of the land. In fact, we see that in employers under 20, defined benefit plans cover about 6 percent of the workers in that category. I represent the State of North Dakota, where most of the

employers are in that category. So there’s an awful lot of upside

growth we can have there.

Does the SAFE design offer you something that you think would

meet the needs of your agency?

Mr. FREDETTE. Yes, it does. I’m the pension amateur, if you will,

the consumer here. But I do know what we need. No. 1, as a small

business, we’re in the business of staying in business, and right

now unemployment is at an alltime low, which means that I want

to hold onto the people I’ve got. They’re very good people. We want

to grow. We want to hire some new people. I want to be able to

attract very good people, top-flight people. So I need a pension

plan, and I’ve heard all kinds of names tossed out—SIMPLE,

SMART, SAFE. I need a real plan——[Laughter.]

Mr. FRADETTE [continuing]. One that, No. 1, it’s got to be affordable. No. 2, it’s got to be flexible. I like that feature about being

able to make up for lost time. And the acronym is fitting. It’s got

to be safe. I will sit here and promise you that I won’t stick my

hand in the employee pension cookie jar and I will make sure that

I put the contribution into the cookie jar that I said I would. But

that’s just me. You’ve got to make it safe and reliable for all employees who are going to be counting on these retirement benefits.

Mr. POMEROY. Very well said. I look at the SMART proposal advanced by the administration as a conceptual endorsement of

SAFE. They didn’t get the details quite right, but in concept they

identified the appropriateness of moving forward with an initiative

to advance defined benefit plans in small employer settings. I think

it’s up to Congress to craft the details in the legislative process,

and I would hope we do it much more along the lines of SAFE.

Let me move to a dimension of distinction between the two plans.

The administration is concerned that we offer a fairly rich incentive to high-paid employees in these small employer settings, usually the owner. They’re concerned that we bring along low-paid employees into the defined benefit process as well, not just have this

be something that would be attractive to sole proprietors, for example, who would not really bring any employees into the defined benefit coverage other than the wealthy businessowner.

Mr. Callahan and Mr. Merolli—and this will be my final question—Mr. Leonard, do you have quick comments in terms of, will

this sweep in, do you think, a number of employees to make it

worthwhile?

Mr. CALLAHAN. The eligibility requirements state that you must

earn $5,000 or more in 2 consecutive years, and be anticipated to

have $5,000 or more the next year. This brings everybody in, including your part-time workers. A good number of part timers earn

over $5,000.

So, certainly, the coverage requirements are met by bringing in

all employees. No exclusions are allowed.
89

Second, the same level of benefits are being provided to the owners of the business as are provided to the rank and file. There are

no differences; there are no permitted disparity that’s allowed

under existing rules. So even though as a percentage of pay, some

of the rank and file may get larger retirement benefits because Social Security is slanted more toward those at a low-pay level, at ultimate retirement from the three-legged stool, the benefits that are

provided from the employer and the incentive that we as a nation

are providing to them are equal.

Mr. MEROLLI. Mr. Callahan basically took the words right out of

my mouth. I was going to say essentially the same thing. Any employee who earns over $5,000 is covered, whether or not they’re employed on the last day of the year. If someone leaves during the

year, as long as they’ve earned $5,000, if the employer chooses to

fund the plan for that year, and makes a 1, 2, or 3 percent, for example——

Mr. POMEROY. Based on your familiarity with the market, this

will be of interest to more than just the sole proprietor or the person——

Mr. MEROLLI. Oh, yes, very, very much so. I think it will be of

interest not only to the sole proprietor, but I think it would be of

interest to the area that we haven’t hit yet, the small business, OK,

the tiny fraction of—there’s only a tiny fraction of small businesses

that have adopted plans, for that very reason, and I think this is

the kind of thing we need because it makes it attractive to those

businesses, to the over 80 percent of businesses under 25 lives that

do not currently have a retirement plan.

Mrs. JOHNSON of Connecticut. We’re down to about 31⁄2 minutes

now. I’m going to have to thank the panel for your help and your

good comments throughout all of this, and we look forward to returning for our final witness. Thank you.

[Recess.]

Mrs. JOHNSON of Connecticut. I’d like to reconvene the hearing.

There are other colleagues that are particularly interested in

your testimony, Mr. Scanlon. So I apologize for starting before they

came, but I also have to leave. So when Mr. Kleczka gets here,

we’ll also kind of recap, or Mr. Coyne, but if we could start now,

then we’ll proceed when they get back, perhaps after you finish, go

back and recap it. If you could start now, I’d appreciate it.

STATEMENT OF WILLIAM J. SCANLON, DIRECTOR, HEALTH

FINANCING AND SYSTEMS ISSUES, HEALTH, EDUCATION,

AND HUMAN SERVICES DIVISION, U.S. GENERAL ACCOUNTING OFFICE

Mr. SCANLON. That’s fine, Madam Chairwoman. I recognize fully

the many demands on your time. So I’m happy to start.

Mrs. JOHNSON of Connecticut. Well, I am very sorry that we had

to slide the hearing 1 hour, and I don’t know whether you heard

my explanation, but I wouldn’t have done it if there weren’t good

reason.

Mr. SCANLON. Right.

Mrs. JOHNSON of Connecticut. I appreciate——

Mr. SCANLON. I understand.
90

Mrs. JOHNSON of Connecticut [continuing]. Your cooperation in

going so late in the evening.

Mr. SCANLON. OK. Well, thank you very much. I’m pleased to be

here today, as you and the Subcommittee have discussed the financial concerns that face America’s retirees. My remarks today rely

very heavily on a report that we provided on early retiree health

care coverage last July for Representative Kleczka.

[For additional information on the report referenced here, see Retiree Health Insurance: Erosion in Employer-Based Health Benefits

for Early Retirees, GAO/HEHS–97–150, July 11, 1997.]

Mr. KLECZKA. Hello.

Mr. SCANLON. As I was mentioning, my remarks are very much

drawn from the report that we prepared for you last July. While

today’s oversight hearing has highlighted the importance of expanding pension coverage so that retirees are not forced to live on

their Social Security benefits alone, many workers face another serious predicament, the lack of affordable health insurance if they

retire before they become eligible for Medicare at age 65.

As you’re well aware, ERISA protects a worker’s pension and

health benefits, but only if the employer provides such fringe benefits. Thus, ERISA requires employers to fund their pension plans

and gives workers vested rights upon meeting certain service requirements.

Health benefits, on the other hand, were excluded from the funding and vesting requirements. In fact, employers commonly finance

health benefits both for active and retired workers on a pay-as-yougo basis. This arrangement leaves workers particularly vulnerable

to economic or other circumstances that might prompt an employer

to reconsider the terms under which health coverage is provided.

New accounting rules that became effective in 1993 and rapidly

escalating health care costs are widely considered to have provoked

such reassessments. If employer’s have reserved the right to do so,

nothing in Federal law prevents them from changing or eliminating

retiree health coverage. In fact, an employer’s freedom to make

such changes is a defining characteristic of America’s voluntary

employer-based system of health insurance.

Slowly, but persistently, large American companies have decided

to terminate retiree health insurance. According to Foster-Higgins,

a benefit consulting firm, fewer than half of the companies with

500 or more employees offer health coverage to early retirees, and

that number has declined from 46 percent in 1993 to 38 percent

today. A similar decline has occurred at firms that offer coverage

to Medicare-eligible retirees.

In addition to fewer employers offering retiree health benefits, a

1995 Labor Department study indicated that the likelihood of retirees enrolling in plans that are offered to them has also dropped because of the increased cost the companies are asking the retirees

to shoulder.

The erosion in employer-based retiree health insurance is particularly troublesome to older Americans approaching or at retirement age. First, they consume medical services at a much higher

rate, and their health care is commensurately more expensive than

that of younger Americans.
91

Second, the alternatives to employer-based coverage are much

more costly, at times to the point of being simply unaffordable, and

not always available to everyone.

The 1997 implementation of the Health Insurance Portability

and Accountability Act, HIPAA, eliminated one potential obstacle

for retirees who lose group coverage through a former employer,

but HIPAA did not address the affordability issue.

For eligible retirees, coverage can no longer be denied or restricted by a preexisting medical condition. HIPAA provides Federal standards to ensure that eligible individuals leaving employerbased group plans can purchase insurance on their own, if they can

afford to do so. In most States, they will have access to the individual insurance market. However, because State laws governing the

operation of individual markets differ, the premium faced by

HIPAA-eligible early retirees varies considerably. Moreover, considering that large companies typically pay 70 to 80 percent of the

premiums of workers, costs in the individual market may come as

a rude awakening, since then is no one else to help share the expense for retirees.

Had HIPAA been in effect in 1996, when the Co. terminated

health insurance for 750 retirees, those affected would have been

guaranteed coverage. They would have faced, though, a standard

premium of almost $8,200 per year for comparable family coverage

in the individual market, provided they did not smoke. It would

have been $11,000 a year if they did smoke—a cost they would

then absorb on their own.

Premiums in other States can be higher or lower. Family coverage for a HIPAA-eligible early retiree would have been about

$6,000 in Arizona, but nearly $12,000 in New Jersey. While New

Jersey prevents carriers from increasing premiums due to health

status, retirees in Arizona and Wisconsin both can be charged more

than the standard premium if they had a preexisting health condition.

Early evidence from the implementation of HIPAA suggests that

the rates developed by insurance carriers for the HIPAAguaranteed products are substantially higher than the prices of

standard products available in the individual market to those who

are healthy. In addition, a number of States are using high-risk

pools, which usually charge more than a standard policy premium,

as the mechanism to guarantee coverage. As a result, these 1996

rates I quoted may understate the cost of HIPAA-guaranteed coverage available to persons in poor health in 1998.

The right to elect COBRA continuation coverage from a former

employer is available to some, but not all retirees. COBRA allows

covered individuals, upon retirement, to continue employer-based

coverage for 18 months if their company does not offer health benefits to retirees. COBRA is not available, however, to retirees whose

employer unexpectedly terminates their health care coverage at

some point after retirement. To address that coverage gap for such

retirees, bills have been proposed by Members of Congress, as well

as the President, to allow retirees to purchase continuation coverage at a cost that reflects their higher utilization of services until

they become eligible for Medicare.
92

1 Retiree Health Insurance: Erosion in Employer-Based Health Benefits for Early Retirees

(GAO/HEHS–97–150, July 11, 1997).

In conclusion, let me note that the erosion in retiree health insurance has been persistent, despite an abatement, at least for the

recent past, in health care inflation and the reemergence of a

strong internationally competitive economy. This continued erosion

raises a fundamental question about what protection will be available for retirees from employer-based insurance.

That concludes my statement. I’d be happy to answer any questions you have.

[The prepared statement follows:]

Statement of William J. Scanlon, Director, Health Financing and Systems

Issues, Health, Education, and Human Services Division, U.S. General

Accounting Office

Madam Chairman and Members of the Subcommittee:

We are pleased to be here today as you discuss issues related to pension benefits

and retirement. As you know, forces in the U.S. labor market have been transforming the cash portion of retirement benefits, and these forces are impinging on retiree

health benefits as well. Several factors suggest that retiree access to affordable

health benefits is becoming an important national issue. These factors include the

downward drift in employers’ commitment to retiree coverage, the consideration of

proposals to raise the Medicare eligibility age to 67, and the dramatic near-term increase in the number of retirees as millions of baby boomers approach retirement

age.

You asked us to comment on the erosion in employer-based health benefits for retirees, especially early retirees who leave the workforce before age 65, when Americans typically become eligible for Medicare. My comments are based on a recent report we prepared at the request of Representative Jerry Kleczka.1 His request was

sparked by the Pabst Brewing Company’s abrupt cancellation of health benefits for

about 750 retirees of its Milwaukee plant in late 1996. My statement today will

focus on three issues: (1) trends in access to employer-sponsored retiree health benefits, (2) the impact on retirees of an employer’s decision to terminate health benefits,

and (3) federal safeguards that protect the rights of retirees who have health benefits.

To address these questions, we reviewed surveys that track the availability of

employer-based health coverage, data from health insurance carriers on the cost of

alternative sources of coverage for individuals whose employers unexpectedly terminate retiree health benefits, applicable federal and state laws and legal precedents,

and our earlier work. (See the list of related GAO products at the end of this statement.)

In summary, retiree access to and participation in private insurance through an

employer has undergone a slow but persistent decline since the early 1990s. There

are several explanations for this erosion in coverage. First, high and rising health

care costs have spurred employers to look for ways to control their benefit expenditures, including eliminating retiree coverage and increasing cost sharing. According

to the Labor Department, increased cost-sharing by retirees has contributed to

fewer electing coverage when it is offered. Second, a new financial accounting standard developed in the late 1980s has changed employers’ perceptions of retiree health

benefits and may have acted as a catalyst for reductions in retiree coverage. The

new rule makes employers much more aware of the future liability inherent in retiree health benefits by requiring them to account for its estimated value. By dropping retiree coverage, a company can immediately improve its balance sheet, making its stock more attractive to investors.

Losing access to employer-based coverage poses major challenges for retirees. The

1997 implementation of the Health Insurance Portability and Accountability Act of

1996 (HIPAA) has eliminated one potential obstacle for retirees who lose group coverage through their former employer—the possibility that coverage in the individual

market will be denied or restricted by a preexisting medical condition. HIPAA provides federal standards to ensure that eligible individuals leaving employer-based

group plans can purchase insurance on their own if they can afford to do so. Because state laws governing the operation of the individual market differ, however,

the premiums faced by early retirees vary substantially. Moreover, considering that

large companies typically pay 70 to 80 percent of the premium, costs in the individ-
93

2 Continuation coverage was mandated by the Consolidated Omnibus Budget Reconciliation

Act of 1986 (COBRA), 29 U.S.C. 1161 et seq. For this reason, continuation coverage is known

by the acronym COBRA. 3 National Survey of Employer Sponsored Health Plans 1996 (New York: Foster Higgins,

1997). Although the Foster Higgins survey dates from 1986, the survey methodology was

changed in 1993 so that the results could be representative of all U.S. employers rather than

just those who responded.

ual market may come as a rude awakening for early retirees. For example, had

HIPAA been in effect in 1996, retirees trying to replace the benefits terminated by

Pabst with comprehensive family coverage from a Wisconsin carrier would have

faced an annual premium of almost $8,200—a cost that they would have had to absorb on their own. And, using 1996 rates again, family coverage for a HIPAAeligible early retiree would have been $6,246 in Arizona but $11,825 in New Jersey.

While New Jersey restricts carriers’ premium-rating practices and generally requires all carriers to set the same rate for all plan participants in a community, eligible retirees in Arizona and Wisconsin can be charged much more than the standard premium if they have a preexisting health condition. Early evidence from the

implementation of HIPAA suggests that rates developed by insurance carriers for

HIPAA guaranteed access products are substantially higher than the prices of

standard products available in the individual market to those who are healthy. As

a result, these 1996 rates may understate the cost of a HIPAA product purchased

in 1998.

A key characteristic of America’s voluntary, employer-based system of health insurance is an employer’s freedom to modify the conditions of coverage or to terminate benefits. When an employer has terminated retiree health benefits, federal

courts have turned to the nature of the written agreements and other pertinent evidence covering the provision of retiree benefits to determine the legitimacy of the

action. In essence, the issues before the court are often a matter of contract interpretation. If the employer explicitly reserved the right in plan documents to modify

health benefits, the courts have generally upheld the termination of coverage. Individuals who are already retired when an employer terminates coverage are not eligible to temporarily continue that firm’s health plan at their own expense.2 COBRA

coverage is only available to active employees who quit or retire or are fired or laid

off. To address the potential gap in coverage when a former employer unexpectedly

terminates health insurance, Members of the Congress as well as the President

have proposed allowing affected retirees to purchase continuation coverage at a cost

that reflects their higher utilization of services until they become eligible for Medicare.

BACKGROUND

Because of the cost, retiree health benefits are a concern to both employers and

older Americans. Employers recognize that these benefits help to retain an experienced workforce but must also consider the cost of providing coverage. Older Americans approaching or at retirement age consume a higher level of medical services,

and as a result, their health care is commensurately more expensive. For workers

under age 65 and not yet eligible for Medicare, the decision to retire may turn on

the continuation of health benefits by an employer. For those 65 or older living on

a fixed income, employer-based benefits may help fill coverage gaps in Medicare,

such as deductibles and copayments or the lack of a prescription drug benefit.

Overall, about one-third of retirees 55 and older received health benefits from a

former employer in 1994. About 75 percent were over age 65, and any employerbased coverage available to them supplemented their Medicare benefits; the remaining 25 percent of retirees were generally ineligible for Medicare because they were

between ages 55 and 65. For the latter group, employer-based benefits were the primary source of coverage.

Bureau of the Census data show that the number of retirees increased from 18.5

million to 23.4 million between 1988 and 1994. However, the first members of the

baby boom generation are now aged 52 and poised to enter retirement, an event

that will begin to dramatically increase the number of retirees.

DECLINE IN ACCESS TO AND PARTICIPATION IN EMPLOYER-BASED RETIREE COVERAGE

Data from an annual survey conducted by Foster Higgins, a benefit consulting

firm, suggest a significant decline between 1988 and 1996 in the availability of retiree coverage from large employers with over 500 workers. Because of a change in

the survey methodology, the pre-1993 data should not be viewed as authoritative.3

However, the data from these two periods appear to be consistent. The data distin-
94

4For additional information on the impact of FAS 106, see Retiree Health Plans: Health Benefits Not Secure Under Employer-Based System (GAO/HRD–93–125, July 9, 1993).

guish between early retirees and those who are Medicare-eligible. Since 1993, coverage for both groups has declined by 8 to 9 percentage points, a continuation of

a trend evident since 1988. As shown by figure 1, early retirees are more likely than

those who are Medicare-eligible to be offered health benefits by a former employer.

In 1997, for example, only 31 percent of Medicare-eligible retirees were offered

health benefits compared with 38 percent of early retirees.

The two primary reasons cited for the decline in employer-based retiree health

coverage are (1) new accounting standards, which highlight the magnitude of this

liability over time, and (2) rapidly rising benefit costs. Since employers typically

cover retiree health costs as they are incurred, the liability represented by a commitment to provide benefits to current and future retirees is largely unfunded. In

1990, the Financial Accounting Standards Board announced the introduction of a

new rule, referred to as FAS 106, regarding these unfunded obligations. Beginning

in 1993, employers were required to include the present value of future costs for

retiree health benefits as a liability on their balance sheets. Many financial experts

are concerned because these long-term liabilities erode equity positions and will become current obligations in future years.4 The new standard does not require that

employers set aside funds to pay for these future costs, and thus it does not affect

their cash flow. However, by dropping retiree coverage, a company can immediately

improve its balance sheet, making its stock more attractive to potential investors.

In responding to benefit consultant surveys, many companies cited FAS 106 as a

reason for modifying retiree health benefits, including the phasing out of such coverage.

The late 1980s was a period of double-digit health care inflation. Although the

growth in premiums has slowed dramatically in the past few years, the percentage

of large firms offering retiree health benefits has continued to drop. Among the reasons cited by Foster Higgins for the slowdown in the growth of employers’ health
95

5Lynn Karoly and Jeannette Rugowski, The Effect of Access to Post-Retirement Health Insurance on the Decision to Retire Early, RAND Reprints: 94–13E (Santa Monica, Calif.: RAND,

1995). 6 U.S. Department of Labor, Pension and Welfare Benefits Administration, Retirement Benefits

of American Workers: New Findings From the September 1994 Current Population Survey

(Washington, D.C.: Department of Labor, Sept. 1995), p. 25. 7Our estimate is based on CPS data from the Bureau of the Census. See Private Health Insurance: Continued Erosion of Coverage Linked to Cost Pressures (GAO/HEHS–97–122, July 24,

1997).

care costs are that more workers moved into managed care plans—including retirees—and the fact that some employers dropped retiree coverage.

As shown in figure 1, employers are less likely to offer coverage to Medicareeligible retirees than to early retirees. There are several potential explanations for

this disparity. First, individuals are not as likely to seek early retirement if they

cannot continue employer-based health benefits. A RAND study of the effect of access to postretirement health insurance found that the offer of continued coverage

made it more likely that men aged 55 to 62 would retire.5 Second, those who retired

early through buyouts may have been guaranteed health benefits as an enticement

to do so. Third, federally mandated COBRA coverage allows some individuals to retire at age 63–1/2 and continue with employer-based group coverage until they become Medicare-eligible at age 65. Finally, employers know that coverage is available

to retirees aged 65 and older through Medicare, an option not open to younger retirees.

COVERAGE INFLUENCED BY FACTORS OTHER THAN AVAILABILITY

The decline in the number of large employers that offer retiree coverage is corroborated by an analysis conducted by the Labor Department’s Pension and Welfare

Benefits Administration. The study, which examined Current Population Survey

(CPS) data, revealed a significant erosion between 1988 and 1994 in the number of

individuals who retained employer-based health coverage upon retirement.6 Only 42

percent of retirees aged 55 and older continued employer-based coverage into retirement in 1994, a decline of 8 percentage points since 1988. Moreover, the percentage

of individuals with employer-based coverage continued to decrease throughout retirement. Thus, only 34 percent still retained coverage several years after retirement.

In addition to the availability of coverage, the Labor Department study suggests

that cost is another factor contributing to the decline in retirees with employerbased insurance. Thus, the propensity for retirees to enroll in employer-based plans

when they are offered has also dropped because of the increased costs retirees are

being asked to shoulder by employers. In both the 1988 and 1994 surveys, individuals who declined employer-based coverage at retirement were asked the reasons for

their decisions. Of the approximately 5.3 million retirees who discontinued

employer-based benefits in 1994, an estimated 27 percent cited the expense as a factor—an increase from 21 percent in the earlier survey. Moreover, there was a 6-

percentage-point increase over the same time period in the number of such retirees

who indicated that they still had health insurance through a plan other than that

of their former employer. Thus, some retirees who find coverage from their own employer too expensive may have switched to plans with lower cost-sharing available

through a working or retired spouse.

Other sources of private insurance do appear to be filling a significant portion of

the gap created by the fact that fewer employers offer retiree health benefits. We

estimated that between 1989 and 1995, the percentage of early retirees with private

coverage fell by only 7 percentage points, compared with a much larger drop in the

number of employers offering retiree coverage.7 If employer-based coverage is not

available, early retirees may postpone retirement, purchase coverage themselves, or

obtain insurance through a working spouse.

CPS data also contain insights on the characteristics of retirees more likely or less

likely to have employer-based coverage. The characteristics for these two groups of

retirees are summarized in table 1.
96

8For details on the individual health insurance market, including its structure, premium

prices, the effect of demographic characteristics, and health plans offered, see Private Health Insurance: Millions Relying on Individual Market Face Cost and Coverage Trade-Offs (GAO/

HEHS–97–8, Nov. 25, 1996). 9See GAO/HEHS–97–8, Nov. 25, 1996, for a discussion of the evaluation process that health

insurance companies have used in providing access to the individual insurance market. 10 HIPAA only guarantees access to the individual market to eligible individuals leaving group

coverage. Thus, someone living in Arizona who wanted to purchase individual coverage but did

not qualify under HIPAA could still be denied an individual policy because of a preexisting

health condition. 11Wisconsin law requires insurers to accept individual applicants who previously had

employer-based insurance if such insurance is not self-funded, but it does not apply to Pabst

retirees because the firm self-funded its health benefits. Self-funded plans are those in which

employers bear much of the financial risk for health claims. Employers that self-fund are not

subject to state insurance regulation.

Table 1: Characteristics of Retirees More and Less Likely to Have Employer-Based Health Benefits

MORE likely to have coverage LESS likely to have coverage

Work for larger firms Work for smaller firms

Have higher preretirement earnings Have lower preretirement earnings

Belong to union Are nonunion

Work in manufacturing or communications/public utilitiesWork in retail sector or service industries

Work for public sector Work for private sector

Are men Are women

Are white Are black or other race

Source: Department of Labor, Pension and Welfare Benefits Administration, analysis of CPS data.

EMPLOYERS’ DECISIONS TO TERMINATE COVERAGE EXPOSE RETIREES TO NEW COSTS

AND RISKS

If available, employer-based group health insurance provides two important advantages to retirees: (1) more affordable health benefits and (2) access to benefits

for those retirees whose health status might otherwise impinge on their ability to

obtain coverage in the individual insurance market. Such insurance is affordable because many employers continue to finance all or a significant amount of their retirees’ health insurance premiums, even though over the last decade retirees have

been required to pay an increasing share of these costs. In addition, the overall premiums for employer-based health plans are generally lower than those in the individual insurance market because the premiums that insurers charge employers are

based on risks spread over an entire group of workers. In contrast, premiums in the

individual insurance market reflect the risk characteristics of each applicant. These

characteristics include not only age but also gender, health status, geographic differences in health care costs, and family size.8 Unless there is a state law prohibiting price differences by age, most carriers charge higher premiums to older applicants.

Before the July 1, 1997, implementation of HIPAA, consumers, including retirees

entering the individual insurance market, often discovered that they were not eligible for insurance or that their coverage was conditioned upon the permanent exclusion from the policy of an existing health problem. Many with specific health problems found coverage only at prohibitive prices. For example, health insurance carriers often declined coverage for acquired immunodeficiency syndrome (AIDS) and

diabetes; offered coverage but excluded conditions such as asthma, ulcers, and glaucoma; and charged higher premiums for plans that covered problems like anemia

and arteriosclerosis.9 HIPAA guarantees access to the individual market by eligible

individuals with qualifying coverage from a former employer—regardless of their

health status—and also provides for the renewability of individual coverage.10 This

guaranteed access is often referred to as ‘‘portability.’’ However, HIPAA offers no

protection to Pabst retirees whose health benefits were terminated in 1996 or to any

retiree who lost employer-based health benefits before its July 1, 1997, implementation date.11

Although HIPAA guarantees access to the individual market, it does not address

the cost of coverage. Retirees no longer covered by their former employer’s group

health plan are likely to pay higher premiums for similar coverage in the individual

insurance market. And with the loss of employer-based coverage, affected retirees

who want to purchase health insurance must now absorb its full cost, which can

be significant. Thus, had HIPAA been in effect in 1996, a Milwaukee retiree who
97

12Family coverage is for a retiree and spouse. The rate is for an individual who does not smoke. A retiree who smokes would pay about $11,000 for family coverage. 13This amount is for nonsmokers aged 55 to 59 with one child. Moreover, New Jersey restricts

carriers’ premium rating practices and generally requires all carriers to set the same rate for

all plan participants within a community. 14The decline of traditional fee-for-service indemnity coverage and the growth in managed

care enrollment exemplifies the ability of employers to modify their health benefit programs. Between 1987 and 1996, employer-based managed care enrollment rose from 27 percent to 74 percent as employers (1) altered the type and mix of health plans offered, sometimes eliminating

the traditional fee-for-service indemnity option; (2) changed employee financial incentives; and

(3) used the information provided to employees to influence their selection of health plans. See

Health Insurance: Management Strategies Used by Large Employers to Control Costs (GAO/

HEHS–97–71, May 6, 1997) for a discussion of the flexibility of large employers as well as the

constraints they face in modifying their health benefit purchasing strategies.

wanted to replace the benefits terminated by Pabst would have paid $8,187 for a

standard family plan with a $250 deductible.12 Since Wisconsin does not restrict the

underwriting practices of carriers, a carrier may choose to charge an unhealthy individual more. Before its decision to terminate health benefits to retired employees

at its Milwaukee plant, Pabst financed the total cost of practically all of the health

plans it offered to retired workers. Given the substantial geographic variability of

health insurance rates in the individual market, HIPAA-eligible retirees will be affected differently. For example, in 1996, a major carrier in New Jersey offered family coverage with a $250 deductible at an annual price of $11,825.13 The price of similar family coverage in Maricopa County, Arizona, was only $6,264 in 1996. However, as in Wisconsin, HIPAA-eligible retirees in Arizona with preexisting conditions

can be charged a premium much higher than the standard.

These 1996 rates may understate the actual cost of a HIPAA guaranteed access

product purchased today. Thus, in September 1997 correspondence to the Chairman

of the Senate Labor and Human Resources Committee on early HIPAA implementation concerns, we reported that (1) premiums for some HIPAA products may be substantially higher than for standard products available to healthy individuals and (2)

the way many carriers will determine future premium rates for portability products

may lead to even higher rates. Some carriers permit HIPAA eligibles to apply for

both a HIPAA product and a lower-cost standard product. Since healthy individuals

are likely to enroll in the less expensive option, only unhealthy individuals would

be enrolled in the HIPAA product—a practice that could result in an increasing spiral of poorer risks and higher premiums.

States were allowed to choose a number of approaches to meet HIPAA’s portability requirements. Thus, 22 states elected to use their high-risk pools to provide

guaranteed access to the individual market for qualified individuals leaving group

coverage. Prior to the enactment of HIPAA, many states had high-risk pools for

those who had been denied coverage or had one of a number of specified health conditions. However, this safety net option often has very limited coverage and lower

lifetime limits. The cost of a high-risk pool can be 50 percent more than the average

or standard rate charged in the individual insurance market for a comparable plan.

For example, the annual premium for a single male aged 50 to 55 in Wisconsin’s

high-risk pool averaged $5,122 in 1996—over $500 more than the cost in the individual insurance market. Wisconsin offers subsidies to families with incomes of less

than $20,000.

LIMITED FEDERAL PROTECTION OF EMPLOYER-BASED RETIREE HEALTH BENEFITS

The Employee Retirement and Income Security Act (ERISA) protects both the

pension and health benefits of workers. It does not, however, mandate that employers offer such benefits. ERISA requires employers to fund their pension plans and

gives employees vested rights upon meeting certain service requirements; health

benefits, on the other hand, were excluded from such funding and vesting requirements. In fact, employer-based health benefits for both active and retired workers

are commonly funded on a pay-as-you-go basis.

Nothing in federal law prevents an employer from cutting or eliminating health

benefits. In fact, an employer’s freedom to modify the conditions of coverage or to

terminate health coverage is a defining characteristic of America’s voluntary,

employer-based system of health insurance.14 While ERISA protects the pension

benefits of retired workers, it offers only limited federal safeguards to retirees participating in a firm’s health benefit plan. ERISA requires companies to make a summary plan description (SPD) available to health plan participants within 90 days

of enrolling. For retirees, the SPD that is in effect at the time of retirement is the

controlling document. The SPD must clearly set out employee rights, including ‘‘information concerning the provisions of the plan which govern the circumstances
98

15 COBRA only covers firms with 20 or more employees who offer health benefits to active

workers.

under which the plan may be terminated.’’ Employers must file these documents

with the Department of Labor, the agency responsible for enforcing ERISA. According to Labor, unless employers have made a clear promise of specific health benefits

for a definite period of time or for life and have not reserved the right to change

those benefits, they are free to cut or terminate health care coverage.

Because federal law preempts state regulation of pension and health benefits, the

rights of active and retired employees under ERISA are determined in federal

courts. In reviewing cases involving changes to health benefit plans by employers,

several federal courts have focused on the actual language used in plan documents

and, if applicable, in collective bargaining agreements. Virtually all employers have

reserved the right to modify health benefits for current and future retirees in such

documents. However, if the language leaves some doubt as to the nature or duration

of benefits, or if there are conflicts in the plan documents, the courts have examined

significant written and oral representations made to employees to determine whether the employer has the right to modify retiree health benefits.

One ERISA protection—the right to elect COBRA coverage from a former employer if a worker is fired, laid off, or leaves a job—is available to some but not all

retirees. Thus, COBRA allows covered individuals, upon retirement, to continue

employer-based coverage for 18 months if their company does not offer health benefits to retirees.15 Those eligible for COBRA coverage may have to pay the entire premium plus an additional 2 percent. For many individuals, the high cost of COBRA

coverage is a shock because under employer-based coverage, large companies typically pay 70 to 80 percent of the premium. COBRA is not available, however, to retirees whose employer unexpectedly terminates their health care coverage at some

point after retirement. To address the coverage gap for such retirees, Members of

the Congress as well as the President have proposed allowing affected retirees to

purchase continuation coverage at a cost that reflects their higher utilization of

services until they become eligible for Medicare.

Madam Chairman, this concludes my statement. I will be happy to answer your

questions.

RELATED GAO PRODUCTS

The Health Insurance Portability and Accountability Act of 1996: Early Implementation Concerns (GAO/HEHS–97–200R, Sept. 2, 1997).

Private Health Insurance: Continued Erosion in Coverage Linked to Cost Pressures

(GAO/HEHS–97–122, July 24, 1997).

Retiree Health Insurance: Erosion in Employer-Based Health Benefits for Early Retirees (GAO/HEHS–97–150, July 11, 1997).

Health Insurance: Management Strategies Used by Large Employers to Control

Costs (GAO/HEHS–97–71, May 6, 1997).

Private Health Insurance: Millions Relying on Individual Market Face Cost and

Coverage Trade-Offs (GAO/HEHS–97–8, Nov. 25, 1996).

Employer-Based Health Plans: Issues, Trends, and Challenges Posed by ERISA

(GAO/HEHS–95–167, July 25, 1995).

Retiree Health Plans: Health Benefits Not Secure Under Employer-Based System

(GAO/HRD–93–125, July 9, 1993).

lon.

Mrs. JOHNSON of Connecticut. Thank you very much, Mr. Scanf

Are you aware of any information as to what it would cost retirees to be allowed to—early retirees—to be allowed to participate in

COBRA? Are you familiar with any studies as to what the problems would be if we looked at that solution?

Mr. SCANLON. I don’t have the specific information about what

the differential might be for early retirees, the cost of care for early

retirees versus other workers. However, it’s something that we

could look into for you and get you some of that information. Clearly, as older individuals, these people have higher expenses, and one
99

of the questions might be as to how much you asked or allowed

them to remain within the group and to enjoy the benefits of group

coverage in a single——

Mrs. JOHNSON of Connecticut. For instance, if the employees of

Pabst had been allowed to exercise COBRA rights, what would it

have cost them as opposed to the $8,000? That is the figure?

Mr. SCANLON. Well, $8,000 was the——

Mrs. JOHNSON of Connecticut. Excuse me. The $8,000 was the individual market, correct?

Mr. SCANLON. The individual market, right.

Mrs. JOHNSON of Connecticut. And if they had been able to exercise a COBRA right, what would it have cost them?

Mr. SCANLON. It would have depended upon the premium for the

Pabst coverage, which generally would be about half the level of

the individual market. Now, again, there may be an issue of whether it’s fair to the younger Pabst workers to allow the older retirees

to receive coverage at the average premium, or whether or not

there should be a surcharge for the fact that this is a more expensive population.

Mrs. JOHNSON of Connecticut. But, in general, it would be about

half of the individual market, the COBRA part?

Mr. SCANLON. Right, but there’s a lot of variation in both individual rates and group rates, but, very often it’s about half.

Mrs. JOHNSON of Connecticut. And are you familiar with any

studies that look at allowing Medicare eligibles to come back into

Medicare, if their retiree plan expires or is terminated, and just

pay the regular Medicare benefit?

Mr. SCANLON. No, I’m not.

Mrs. JOHNSON of Connecticut. Because, in a sense, the government hasn’t been caring for them. So we have gotten a good deal,

say, if they’re covered the first 10 years of their retirement by their

employers’ plan. So to let them, then, sign up at whatever the average Medicare premium is at that time, or the appropriate Medicare

premium at that time, seems to me a good deal for the government

and a good deal for them.

Mr. SCANLON. I’m not aware of studies that have looked at companies that have maintained full coverage. I do know that many

companies coordinate their benefits, so that as an individual becomes eligible for Medicare, they do enroll in the program, and

then the employer’s obligation will decline, and there may be quite

a generous Medigap policy, basically, that one is getting from their

employer.

Mrs. JOHNSON of Connecticut. Thank you.

Mr. Kleczka.

Mr. KLECZKA. Thank you, Madam Chair. First of all, let me

thank the chairwoman for permitting GAO and Mr. Scanlon to appear before the Subcommittee today to share with us a report that

was compiled at my request, and it was a report that had its roots

in the Pabst situation, as Mr. Scanlon has pointed out.

I think what the report does indicate is a very, very disturbing

trend in this country, wherein for this employee group we’re seeing

a rapid decline of employer sponsored health insurance. I think

that has given rise to legislation not only introduced by myself, but

clearly pushed by the administration, to provide some type of a ve-
100

hicle for this segment of our society, be it an early retiree at age

55, whose company previously covered him or her, and then withdrew the coverage, like Pabst, or an employee who has been laid

off permanently from his company; the company has closed, so that

naturally would close off any COBRA option.

And the administration is proposing a buy in to the Medicare

Program. For those 55 to 62, it would be a buy in at 100 percent

of the cost. At 62 to 65, provided would be a premium with some

subsidy, which would be recouped after age 65.

I think those two items by the President in his bill, and the third

being comparable to mine, which is the buy in for COBRA, are just

totally essential if we are going to provide some modus of coverage

for this population within our society.

My question, Mr. Scanlon, would be as follows: Do you think the

legislative proposals I just mentioned could be the impetus for employers to cancel employee health coverage and exacerbate the

problem that we’re seeing. The rationale the employer could use is,

well, gosh, the government provides coverage; why should we? Do

you see that as being one of the effects, if in fact Congress, in its

wisdom, would move ahead on one of these proposals?

Mr. SCANLON. There may be some occurrence of that in what we

do notice, in terms of how employers are providing retiree coverage

today. There is greater generosity for early retirees than there is

for retirees that are eligible for Medicare. And it’s speculation, but

one of the hypotheses that’s suggested is that employers recognize

that retirees under the age of 65 face very difficult insurance

choices because of the portability issue, and that people over 65

don’t. If there was public support for more affordable coverage for

younger persons, maybe some employers would opt to do that.

How strongly that there would be that kind of a response is impossible to say.

Mr. KLECZKA. And, clearly the States that have gone into the

risk premiums, like the State of Wisconsin, is clearly not the answer with average or little means. I think you pointed out the premium base for the State of Wisconsin for somebody who was in a

risk pool; it’s very, very expensive coverage. To think somebody

who took early retirement, to think that that person might have

the expendable resources to buy a $6,000 or $8,000 health plan is

truly not the case. Those people eventually will go bare, will go

without, and after one or two serious health care problems, they’re

going to be on the government program called Title 19 at some

point, should they expend their assets to that level.

It seems to me that when we talk about retiree health care, for

those employees in a bargaining unit that are represented, those

benefits were not given to them by the grace of God or the generosity of the employer. Many of them gave up other benefits throughout their working years, be it pay increases or whatever, and it

seems to me that for those situations we should expand the Pension Guarantee Corporation to provide some guarantee for those

types of benefits also.

I asked the Director of the PBGC. He’s going to get back to me,

but have you any thoughts on that particular expansion of the current PBGC law?
101

Mr. SCANLON. Well, I heard your question earlier, and I think it

triggered a number of thoughts. I thought as a potential early retiree that I would be very reassured by this kind of a guarantee.

However, as an analyst, what I started to think about was exactly

what this guarantee would provide, and how you would structure

the health insurance benefit that employers would be offering and

that their contribution to the PBGC would guarantee.

One of the difficulties that we have in the health care, and one

of the things that has put pressure on employers, is the fact that

we have been very poor at controlling inflation. So that with a

guarantee over a long period of time, we run the risk that we

haven’t in some respects saved enough to be able to fulfill that

guarantee.

So I think that the idea is intriguing. It may be most beneficial

for some type of guaranteed coverage for early retirees, where

you’re talking about a fixed period of time, and it may also involve

some switching from the concept of providing a defined benefit insurance plan, where you’re guaranteeing people coverage to certain

services, to a defined contribution, where you’re going to empower

them to be able to purchase insurance. But they may have to supplement it more if health inflation is so great that it outstrips the

guarantee. In either case, they would be better off than they are

currently.

Mr. KLECZKA. They surely would. We’ve seen a decline of 46 percent to 38 over a period of 5 years. Do you forecast or do you see

that this decline is going to continue or have we leveled off, or

where are we?

Mr. SCANLON. This is a relatively new phenomenon. So it’s hard

to be very confident that we are talking about a trend. What’s disturbing about it is that we are seeing the decline continue even

though we have a very, very strong economy right now, and even

though we’ve brought health care costs sort of under control for the

moment.

If you look back to the 1992–93 period, when the accounting

standard changes were introduced, you saw a very dramatic drop,

and you can very easily tie that to the accounting standards. Then

you could also think about health inflation, and that sort of exacerbated the situation. If you ask yourself today, why is it continuing,

the situation suggests that it may continue for the short term at

least.

Mr. KLECZKA. Let’s just return back to the health inflation. Has

it not been retarded over the years? I know when we talked about

the national health care bill in 1993, health care inflation was very

moderate for that year and the next year. When the bill was moved

off the front burner, we saw some moderate growth, but then we

have the HMOs, health maintenance organizations, and the PPOs,

preferred provider organizations, and the managed health care

plans come in. What is the current health care inflation rate for,

let’s say, the last year?

Mr. SCANLON. I don’t know the exact rate, but, basically, we have

been very happy that we have one of the lowest rates that we’ve

had in a very, very long time. We’re starting to approach the point

that health care inflation is almost equal to ordinary inflation, and

as you know, ordinary inflation is relatively low these days. So we
102

have succeeded. Since 1993–1994, we’ve seen a dramatic change

and the rate of health inflation has gone way down.

Mr. KLECZKA. So health care costs can’t be the culprit in these

employers’ denying. Definitely the accounting rule change was——

Mr. SCANLON. Right, right.

Mr. KLECZKA [continuing]. And we did look into that some time

ago.

Mr. SCANLON. Right. And, historically, while costs may have

been a culprit, they should be much less of a culprit today.

Mr. KLECZKA. But I think we’re going to see this trend continue,

as you estimate at this point.

Well, thank you very much for appearing, Mr. Scanlon. I think

your report and your testimony indicate that there’s a serious problem in this country for those retirees, early and at 55, and those

retirees at age 62, when it comes to their health insurance cost.

Medicare does not pick them up to 65 years old.

Last year there was a proposal in the Senate to expand or to lift

that age requirement to 67, and it seems that what is going to happen to these people age 55 to, say, 65—there’s a 10-year gap there,

and if they’re going to go out to the private market and start paying $6,000 to $8,000 per year for coverage, clearly, they’re not going

to survive. There have to be some other arrangements.

So I think your report, in my estimation, will help when the

President’s proposal comes up to expand the buy in to Medicare

and/or my legislation, which would just expand COBRA.

So thank you very much for appearing today.

Mr. SCANLON Thank you.

Mr. KLECZKA [presiding]. Thank you.

Since I’ve been given the gavel, and I’m in the Minority party,

we have other witnesses outside that we’re going to call. [Laughter.]

CNN is coming with cameras. We’ve got a real show. [Laughter.]

But, seriously, that is all the business to come before the Subcommittee. The Subcommittee does now adjourn.

[Whereupon, at 6:01 p.m., the hearing was adjourned, subject to

the call of the Chair.]

[Submissions for the record follow:]

Statement of Hon. Roy Blunt, a Representative in Congress from the State

of Missouri

As a member concerned with retirement income security, I am filing this statement to compliment the subcommittee on its long standing interest in this issue and

to suggest a proposal for your consideration.

Although ERISA was enacted to enhance retirement benefit security, current data

suggests that it is not working for all Americans. Indeed, as the Treasury Department recently reported, over half of all American workers lack coverage by a private

pension plan. That gap is not evenly distributed among all employees, but is concentrated among those who work for small employers. Only 20 percent of workers

in firms with fewer than 100 employees have pension coverage.

Recent efforts, including the SIMPLE plan adopted in 1996 and the SMART plan

and payroll deduction IRAs included in the President’s FY 99 Budget proposal, approach this problem with design-based retirement plans that provide guaranteed

minimum benefits for all employees who meet certain minimum service requirements. To encourage adoption, these arrangements are exempt from certain of the

most burdensome administrative requirements. However, benefits provided under

these arrangements are very limited (annual employee contributions under the SIMPLE plan are limited to $6,000 with matching contributions capped at 3% of the
103

employee’s compensation, and annual benefit accruals under the SMART plan would

be limited). Thus, we currently maintain a two tier system, comprised of:

• qualified plans which are permitted to provide significant retirement benefits

(i.e., annual contributions of up to $30,000 under a defined contribution arrangement, and annual benefits of up to $125,000 (for 1998) payable under a defined benefit pension plan), but are subject to the full range of tax qualification requirements

and ERISA reporting and disclosure rules; and

• special, design-based plans for certain small employers under which reduced administrative burdens buy significantly reduced benefit opportunities.

Similarly, the SAFE proposal, developed by Chairman Johnson and members of

the subcommittee is a defined benefit plan that would limit benefit accruals to a

maximum of 3% of compensation, and would require the plan to be funded with annuities.

ADDITIONAL RELIEF IS NEEDED

Unfortunately, these are often not viable options for the small employer who is

willing to provide more generous benefits for its employees if plan costs consist primarily of funding benefits instead of unnecessary administrative expenses. Thus,

while I support enactment of a payroll deduction IRA and a simplified defined benefit plan, I have been working with others to develop a hybrid approach, applicable

to small employers.

As described below, the bill I plan to introduce will, effective for years after enactment, create a new design-based plan permitting eligible small employers who agree

to provide significant benefits to all employees to sponsor a hybrid defined contribution plan providing full benefits; provide a uniform definition of eligible small employers; simplify the eligibility requirements applicable to all small employer plans;

repeal the ‘‘top heavy’’ rules; permit plans to use a uniform definition of compensation for purposes of plan qualification and calculating permitted deductions; simplify

annual reporting requirements; and provide a tax credit for certain start-up expenses. Each of these provisions is discussed below in detail.

DESIGN-BASED PLAN

My bill creates a new, simplified design-based plan for small employers. Unlike

prior simplified plans (e.g., SEPs, SARSEPS, SIMPLE and the proposed SMART

plan) this proposal would permit small employers to provide the same level of benefits permitted under qualified defined contribution plans (i.e., annual contributions

equal to the lesser of a specified dollar amount ($30,000 for 1998) or 25 percent of

compensation) to their employees.

In exchange for the employer’s agreement to provide 100 percent coverage, accelerated vesting, minimum non-integrated benefits, and to accept limitations on investments in employer securities, the eligible small employer would be permitted to

provide these benefits under a single plan that combines the features of a present

law money purchase pension plan and a discretionary contribution plan, thereby

eliminating the need to adopt two plans with duplicate set-up, administration and

compliance costs. The small employer retirement plan I propose will be treated as

a new discretionary contribution plan that is not a profit-sharing, stock bonus or

money purchase pension plan.

SMALL EMPLOYER DEFINED TO INCLUDE EMPLOYERS WITH 100 OR FEWER EMPLOYEES

My proposal incorporates the most commonly accepted definition (used for purposes of the SIMPLE plan, the Administration’s FY 99 Budget proposals for SMART

plans and the proposed tax credit for plan start up costs) of a ‘‘small employer’’ as

one with 100 or fewer employees. Administration data suggests that it is appropriate to target such employers because only 20 percent of employees in such firms

currently participate in employer-sponsored retirement plans.

The Administration’s proposed SMART plan would not be available to a small employer that is also a ‘‘professional service organization’’ which would include organizations dedicated to health, law, engineering, architecture, accounting, actuarial

services, performing arts or consulting. Given that the majority of employers with

fewer than 100 employees fall into one of these categories, excluding such employers

from utilizing the simplified plans would exclude from plan coverage a large percentage of the employees targeted for coverage. Accordingly, my proposal will not

include such restrictions.
104

ELIGIBILITY SAFE HARBOR

Under my proposal, small employers who are willing to provide benefits for all

employees who meet statutory minimum age and service requirements (thereby surrendering their flexibility to arbitrarily exclude 30 percent of such employees),

would come under a safe harbor permitting (i) use of a single eligibility computation

period—the plan year; and (ii) a single annual entry date—as of the first day of the

plan year following the plan year in which the age and service requirements are

satisfied.

REPEAL THE ‘‘TOP HEAVY’’ RULES

In order to maintain qualified status, all retirement plans must satisfy certain requirements designed to ensure that the plan provides meaningful benefits to a nondiscriminatory group of employees. In addition, under current law, all qualified

plans must comply in form and operation with special ‘‘top-heavy’’ rules designed

to protect non-key employees. Under these rules, a top-heavy plan must, among

other things, implement accelerated vesting schedules and provide minimum benefits for non-key employees,.

Since the top heavy rules were enacted in 1982, numerous changes have been

made to plan qualification rules that render these restrictions virtually meaningless.

For example, the Tax Reform Act of 1986 made substantial revisions to the nondiscrimination and Social Security integration rules, expanded the limit on pensionable compensation and accelerated vesting schedules for all plans (although not to

the extent required for top heavy plans). The Small Business Jobs Protection Act

repealed, effective for years after 2000, the combined plan limit applicable to all

plans, including the restricted limit applicable to certain top heavy plans. And, the

Administration’s FY 99 Budget proposals would further accelerate vesting by applying the top heavy plan vesting schedules to all employer matching contributions

made under 401(k) plans. I believe these broader changes make the special topheavy plan rules obsolete, which is why I propose to repeal these rules.

UNIFORM DEFINITION OF COMPENSATION

Under present law, tax-qualified retirement plans must use ‘‘gross compensation’’

(i.e., taxable compensation plus pre-tax salary deferrals) to determine whether the

plan satisfies limitations on benefits and contributions and whether an employee’s

elective deferrals meet nondiscrimination rules. However, they must use ‘‘net compensation’’ (i.e., taxable compensation less the amount of any pre-tax salary deferrals) to determine the deductibility of employer contributions to the plan. Because

of the administrative costs associated with having different definitions of compensation for different purposes, my proposal would establish the use of ‘‘gross compensation’’ for all purposes.

SIMPLIFIED 5500 FILING REQUIREMENTS FOR SMALL EMPLOYERS

Although efforts have been made to reduce unnecessary administrative burdens

on small employers, (e.g. TRA 97 made it unnecessary to file Summary Plan Descriptions and Summaries of Material Modifications with the Department of Labor,

and the FY 99 Budget Proposal would, at least for SMART plan sponsors, provide

unspecified relief from burdensome filing requirements) more needs to be done. The

breadth of relief must be expanded to apply, not only to SMART plan sponsors, but

to all small employers that use standard documents. Specifically, I recommend that: • plans in which the only participant is the employer (or the employer and spouse), that have at the end of the plan year plan assets of $500,000 (as opposed

to $100,000) or less be exempt from filing Form 5500; and • businesses with fewer than 25 employees on the first day of the plan year be

permitted to file a form 5500EZ, even if additional employees are hired during the

year, and regardless of the value of the plan assets.

TAX CREDIT FOR CERTAIN PLAN START-UPS

Finally, it is a fact that regardless of what simplification measures are enacted,

implementing a new retirement plan necessarily involves certain start-up costs. In

recognition of this fact, the Administration’s FY 99 Budget Proposal, effective beginning in the year of enactment, would provide a new tax credit for small employers

who adopt a SIMPLE, a SMART, any other tax-qualified plan or salary deduction

IRA on or before December 31, 2000. Applicable to small employers that did not

maintain any retirement plan or payroll deduction IRA in 1997, the credit would

be equal to 50 percent of the administrative and retirement education expenses in-
105

1The views Expressed in this statement are solely those of the author and should not be attributed to the Employee Benefit Research Institute, or the EBRI Education and Research Fund,

its officers, trustees, sponsors, or other staff, or to the EBRI–ERF American Savings Education

Council. The Employee Benefit Research Institute is a nonprofit, nonpartisan, public policy research organization which does not lobby or take positions on legislative proposals. 2These figures are Employee Benefit Research Institute tabulations of the 1993 Current Population Survey employee benefits supplement.

curred in establishing the plan, capped at $2,000 for the first year, and $1,000 for

the next two years. While I applaud this effort, I believe further relief is appropriate. Accordingly, I recommend that the credit be extended to cover at least the

first five years of plan operation.

CONCLUSION

I hope as you move forward with pension reform you will take seriously the proposals I have advanced and include the hybrid plan described above in your recommendations.

Statement of Paul J. Yakoboski, Ph.D., Employee Benefit Research

f

Institute 1

INTRODUCTION

As of 1993, the latest year for which nationally representative data are available,

64 percent of all civilian nonagricultural wage and salary workers worked for an

employer that sponsored a retirement plan, and 49 percent of all workers participated in a retirement plan sponsored by their employer.2 Probably the most notable

gap in employment-based retirement plan coverage is among small employers.

While 85 percent of workers at employers with 100 or more employees have an employer that sponsors a plan, only 50 percent of workers at employers with 25 to 99

workers, and 20 percent of workers at employers with fewer than 25 employees have

an employer that sponsors a plan. The findings regarding participation are similar.

Two-thirds of workers at employers with 100 or more employees actually participate

in an employment-based retirement plan, compared with 36 percent of workers at

employers with 25 to 99 workers and 15 percent of those at employers with fewer

than 25 workers.

WHY THE GAP?

Why do sponsorship rates and participation rates lag so much among small employers? EBRI first examined this issue 10 years ago in a book entitled Pension Policy and Small Employers: At What Price Coverage? Chief among the reasons highlighted as to why small employers do not sponsor a retirement plan were financial

cost/lack of affordability and the burden of administering a plan, with the latter

often contributing to the former. Other factors cited were the lack of need for a plan

and a preference among employees for cash compensation. Many employers noted

that they had a high turnover work force and therefore their employees would not

be interested in a plan with vesting requirements. They also felt that retirement

income was at best a remote goal for the young workers who often make up their

work force. Finally, small employers expressed a preference to reward performance

selectively by paying bonuses. What developments would lead small employers to

start a plan? The same research indicated that improved business profitability, increased tax advantages, and increased employee demand may lead small employers

without a plan to start one.

Coverage rates have remained basically unchanged among small employers over

time. A list of likely reasons for not having a plan would look pretty much the same:

cost/administrative burden, low/uncertain profits, and lack of demand on the part

of workers at small employers would likely lead the list. However, because of a lack

of recent research in this area, EBRI, ASEC, and Mathew Greenwald and Associates

have expanded the 1998 Retirement Confidence Survey project to include a survey

of small businesses, both those with a retirement plan and those without one. The

survey will explore the reasons that small employers do not offer a retirement plan

and the changes that would lead them to consider doing so. Among small employers

that do offer a retirement plan, the survey will explore the types of plans they offer

and their motivations in offering these plans. Results should become available in

May, and EBRI would be happy to share them with the committee when available.
106

3Survey results were based on responses from 26 firms, including two-thirds of the largest

25 mutual fund firms. The survey objective was to quantify the number of SIMPLE plans and

accounts that were established between January 1 and July 31, 1997, among members of ICI’s

pension committee. 4Given the limited nature of the sample, these figures likely undercount significantly the total

number of SIMPLE plans established during this time period 5The survey used ‘‘accounts established per employer plan’’ as a proxy for employer size,

which likely understates the average size of each employer to some degree.

RECENT DEVELOPMENTS

The Small Business Job Protection Act of 1996 created a simplified retirement

plan for small business called the savings incentive match plan for employees (SIMPLE). SIMPLE plans can be adopted by employers who employ 100 or fewer employees on any day during the year and who do not maintain another employment-based

retirement plan.

A SIMPLE plan can be either an individual retirement account (IRA) for each employee or part of a 401(k) plan. If established in IRA form, a SIMPLE plan is not

subject to the nondiscrimination rules generally applicable to qualified plans (including the top-heavy rules), and simplified reporting requirements apply. Within

limits, contributions to a SIMPLE plan are not taxable until withdrawn.

A SIMPLE plan can also be adopted as part of a 401(k) plan. In that case, the

plan does not have to satisfy the special nondiscrimination tests applicable to 401(k)

plans and is not subject to the top-heavy rules. The other qualified plan rules continue to apply.

Small employers have established SIMPLE plans in greater numbers than most

in the retirement community anticipated. Although no nationally representative

data are yet available, a non-random survey by the Investment Company Institute

(ICI) of its members 3 indicates that plan establishment has been concentrated

among employers with under 10 employees and that the SIMPLE–IRA is preferred

over the SIMPLE-401(k). More specifically, the survey found that 18,261 SIMPLE

IRA plans, with 95,431 participants, had been established, and 42 SIMPLE 401(k)

plans, with 785 participants, had been established.4 Eighty-seven percent of SIMPLE plans were established by employers with 10 or fewer employees, and 97 percent of employers establishing a SIMPLE plan had 25 or fewer employees.5

Congress is now considering proposals by the Clinton Administration and others

to create a ‘‘simple’’ version of a defined benefit plan for small employers. Creation

of such a plan would mean that small employers interested in establishing a retirement plan via the ‘‘simple’’ route would no longer be restricted to choosing a defined

contribution plan. Other proposals being considered to promote retirement plan coverage among small employers include a tax credit for businesses establishing a new

plan.

CONCLUSION

As Congress considers various proposals to promote retirement plan coverage

among small employers, expectations should be kept realistic. Coverage rates among

small employers are unlikely ever to approach those of large employers simply because of the financial reality of small and uncertain profits faced by many small

businesses, combined with what is currently a weak interest in contributing to a retirement plan among many young and low-earning workers. These realities mean

that is not enough simply to target the small employer, but it is also important to

target employees with messages regarding the need to plan and save for their retirement.

Æ