United States Government Accountability Office

GAO Testimony before the Committee on the 

Budget, House of Representatives

PRIVATE PENSIONS: For Release on Delivery 

Expected at 9:30 a.m. EDT

Thursday, June 9, 2005 

The Pension Benefit 

Guaranty Corporation and 

Long-Term Budgetary 

Challenges 

Statement of David M. Walker

Comptroller General of the United States 

GAO-05-772T
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-772T.

To view the full product, click on the link 

above. 

For more information, contact Barbara 

Bovbjerg at (202) 512-7215 or 

bovbjergb@gao.gov. 

Highlights of GAO-05-772T, testimony 

before the Committee on the Budget, 

House of Representatives 

June 9, 2005

PRIVATE PENSIONS

The Pension Benefit Guaranty 

Corporation and Long-Term Budgetary 

Challenges 

A combination of recent events, long-term structural problems, and 

weaknesses in the legal framework governing the defined benefit system has 

left PBGC with a significant long-term deficit and many large plans badly 

underfunded. Lower interest rates and equity prices since 2000 have 

increased the present value of pension liabilities and lowered the value of 

significant portions of pension plan assets. Meanwhile, PBGC is exposed to 

significant risk from underfunded plans in key industries at the same time 

that its revenue base is threatened by the long-term decline in defined 

benefit plan participation. In addition, the basic legal framework governing 

pension insurance and plan funding has failed to help ensure that plan 

sponsors deliver on their pension promises and safeguard the PBGC’s 

financial condition. PBGC’s current premium structure does not properly 

reflect the risks to its insurance program and facilitates moral hazard 

behavior by plan sponsors. Further, current pension funding rules have not 

provided sufficient incentives for plan sponsors to properly fund their 

benefit obligations. As a result, bankrupt plan sponsors, acting rationally and 

within the rules, have transferred the obligations of their large and 

significantly underfunded plans to PBGC. These weaknesses contribute to 

and are exacerbated by a lack of timely, accurate and transparent 

information that make it difficult for participants, investors, and others to 

have a clear understanding of the true financial condition of pension plans. 

Comprehensive reform is required to ensure that workers and retirees 

receive the benefits promised to them. Ideally, effective reform would 

• improve the accuracy of plan funding measures while minimizing 

complexity and maintaining contribution flexibility; 

• revise the current funding rules to create incentives for plan 

sponsors to adequately finance promised benefits; 

• develop a more risk-based PBGC insurance premium structure 

and provides incentives for sponsors to fund plans adequately; 

• address the issue of underfunded plans paying lump sums and 

granting benefit increases; 

• modify PBGC guarantees of certain plan benefits 

• resolve outstanding controversies concerning hybrid plans by 

safeguarding the benefits of workers regardless of age; and 

• improve plan information transparency for pension plan 

stakeholders without overburdening plan sponsors. 

Pension reform is only part of a broader fiscal, economic and retirement 

security challenge. Looking ahead in the federal budget, Social Security, 

together with Medicare and Medicaid, will dominate the federal 

government’s future fiscal outlook. Reform should also be considered in the 

context of the problems currently facing our nation’s Social Security system. 

Importantly, as is the case with Social Security, acting sooner rather than 

later will make comprehensive pension reform less costly and more feasible.

More than 34 million workers and 

retirees in over 29,000 singleemployer defined benefit plans rely 

on a federal insurance program 

managed by the Pension Benefit 

Guaranty Corporation (PBGC) to 

protect their pension benefits. 

However, the single-employer 

insurance program’s long-term 

viability is in doubt, and this may 

have significant implications for 

the federal budget. In fiscal year 

2004, PBGC’s single-employer 

pension insurance program 

incurred a net loss of $12.1 billion, 

and the program’s accumulated 

deficit increased to $23.3 billion. 

Further, PBGC has estimated that it 

is exposed to almost $100 billion of 

underfunding in plans sponsored 

by companies with credit ratings 

below investment grade. 

This testimony provides GAO’s 

observations on the nature of the 

challenges facing PBGC and why it 

is preferable for Congress to act 

sooner rather than later. This 

testimony also notes the broader 

context in which reform proposals 

should be considered and the 

criteria that GAO has suggested for 

reform. 
Page 1 GAO-05-772T 

Mr. Chairman and Members of the Committee: 

I am pleased to be here today to discuss the problems and long-term 

challenges facing the defined benefit (DB) pension system, the Pension 

Benefit Guaranty Corporation (PBGC), the retirement security of workers 

and retirees covered by DB plans, and American taxpayers. In particular, I 

will discuss the factors contributing to those problems and suggest 

elements of the comprehensive reform necessary to address them.1

 As I 

have noted before, these problems are a subset of the broader challenges 

facing the federal government and our nation’s retirement income system.2

These programs, which include Social Security, Medicare, and Medicaid, 

represent large, growing, and unsustainable claims on the federal budget 

because America’s population is aging, life expectancies are increasing, 

workforce growth is slowing, and health care costs are rising. 

The long-term effect of federal retirement programs on the budget is so 

significant that neither slowing the growth of discretionary spending nor 

allowing tax cuts to expire—nor both options combined—would by 

themselves eliminate our long-term fiscal imbalance (see fig. 1). Therefore, 

as we discussed in our 21st Century Challenges report,3

 tough choices 

need to be made about the appropriate role and size of the federal 

government—and how to finance that government—and how to bring the 

panoply of federal policies, programs, functions and activities into line 

with the realities of today’s world and tomorrow’s challenges. More 

specifically to federal retirement policy, we need to make choices about 

how to promote current and long-term economic security in retirement. In 

that latter context, comprehensively considering our citizens’ needs for 

income, health care, and long-term care is important. 

From our nation’s overall fiscal perspective, continuing on our current 

unsustainable fiscal path will gradually erode, if not suddenly damage, our 

economy, our standard of living, and ultimately our national security. 

 1

Many of these elements are explored in greater detail in a report that GAO is releasing 

today. GAO, Comptroller General’s Forum: The Future of the Defined Benefit System and 

the Pension Benefit Guaranty Corporation, GAO-05-578SP (Washington, D.C.: 

June 9, 2005). 

2

GAO, Long-Term Fiscal Issues: The Need for Social Security Reform, GAO-05-318T

(Washington, D.C.: Feb. 9, 2005). 

3

GAO, 21st Century Challenges: Reexamining the Base of the Federal Government, 

GAO-05-325SP (Washington, D.C.: Feb. 2005). 
Page 2 GAO-05-772T 

Therefore, we must fundamentally reexamine major spending and tax 

policies and priorities in an effort to recapture our fiscal flexibility and 

ensure that our programs and priorities respond to emerging security, 

social, economic and environmental changes and challenges. 

Figure 1: Composition of Spending as a Share of GDP Assuming Discretionary 

Spending Grows with GDP after 2005 and All Expiring Tax Provisions Are Extended 

Notes: Although expiring tax provisions are extended, revenue as a share of gross domestic product 

(GDP) increases through 2015 due to (1) real bracket creep, (2) more taxpayers becoming subject to 

the alternative minimum tax, and (3) increased revenue from tax-deferred retirement accounts. After 

2015, revenue as a share of GDP is held constant. 

PBGC is an excellent example of the need for Congress to reconsider the 

role of government programs, in general, and federal retirement programs, 

in particular, in light of past changes and 21st century challenges. In 1974, 

Congress passed the Employee Retirement Income Security Act (ERISA) 
Page 3 GAO-05-772T 

to respond to trends and challenges that existed at that time.4 Among other 

things, ERISA established PBGC to pay the pension benefits of defined 

benefit plan participants, subject to certain limits, in the event that an 

employer could not.5

 When ERISA was enacted, defined benefit pension 

plans were the most common form of employer-sponsored private pension 

and were growing both in number of plans and in number of participants. 

Today, defined benefit pensions cover an ever-decreasing percentage of 

the U.S. labor force, a fact that raises questions about federal policy on 

pensions in general, and defined benefit plans and the PBGC, in particular. 

I would now like to outline the challenges facing the defined benefit 

pension system and PBGC and suggest a framework for evaluating 

potential policy responses. In summary, a combination of recent events, 

long-term structural problems, and weaknesses in the legal framework 

governing pensions has left PBGC with a significant long-term deficit and 

many large plans badly underfunded. Lower interest rates and equity 

prices since 2000 have combined to significantly increase pension 

underfunding through an increase in the present value of pension 

liabilities, and decreases in the value of pension plan assets. Meanwhile, 

intense cost competition as a result of globalization and deregulation has 

led to bankruptcies of plan sponsors in key industries like steel and 

airlines, and is exposing PBGC to the risk of significant future losses in 

these and other industries. This competitive restructuring has occurred 

simultaneously with a long-term decline in defined benefit plan 

participation that threatens PBGC’s revenue base. In addition, the basic 

legal framework governing pension insurance and plan funding has failed 

to safeguard the benefit security of American workers and retirees and the 

PBGC’s financial condition. Too many companies are making pension 

promises that they are not required to deliver on, in part because of 

perverse incentives and “put options” created under the current pension 

insurance system. 

PBGC’s current premium structure does not properly reflect the risks to 

its insurance program and facilitates moral hazard by plan sponsors. 

 4

One impetus for the passage of ERISA was the failure of Studebaker’s defined benefit 

pension plan in the 1960s, in which thousands of plan participants lost most or all of their 

pensions. 

5

Some defined benefit plans are not covered by PBGC insurance; for example, plans 

sponsored by professional service employers, such as physicians and lawyers, with 25 or 

fewer employees. 
Page 4 GAO-05-772T 

Further, as we have shown in a recent report, current pension funding 

rules have not provided sufficient incentives, transparency, and 

accountability mechanisms for plan sponsors to properly fund their 

benefit obligations and deliver on their promises.6

 As a result, bankrupt 

plan sponsors, acting rationally and within the rules, have transferred the 

obligations of their large and significantly underfunded plans to PBGC. 

These weaknesses in the legal framework contribute to and are 

exacerbated by a lack of transparent information that makes it difficult for 

interested stakeholders to understand the true financial condition of and 

risk associated with selected pension plans. 

Given pension plans’ crucial significance to our nation’s retirement 

security net, it is useful to compare the challenges facing PBGC’s 

insurance program and Social Security. Both systems require meaningful, 

comprehensive reform that restores solvency, assures sustainability, and 

protects the benefits of participants. Similar to that of Social Security, 

PBGC’s current condition does not represent a crisis, though delaying 

reform will result in serious adverse consequences for individuals, the 

federal budget, and our economy. Furthermore, like Social Security, PBGC 

has plenty of cash on hand today to pay benefits to participants in the 

short term, but it faces large and growing unfunded obligations and 

escalating cash flow deficits in the future. 

The termination of United Airlines’ defined benefit pension plans is just 

the latest in a recent series of large, underfunded plans taken over by 

PBGC, and will not be the last. In July 2003, GAO designated PBGC’s 

single-employer insurance program as “high-risk,” given its deteriorating 

financial condition and long-term vulnerabilities.7

 At the end of fiscal year 

2004, PBGC estimated that it was exposed to almost $100 billion of 

underfunding in plans sponsored by companies with credit ratings below 

investment grade. Though smaller in scale than Social Security, Medicare, 

and Medicaid, PBGC’s deficit threatens to worsen our government’s longterm fiscal position.8

 While PBGC is not explicitly backed by the full faith 

 6

GAO, Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate 

Weaknesses in Funding Rules, GAO-05-294 (Washington, D.C.: May 31, 2005). 

7

GAO, Pension Benefit Guaranty Corporation Single-Employer Insurance Program: 

Long-Term Vulnerabilities Warrant “High Risk” Designation, GAO-03-1050SP

(Washington, DC: July 23, 2003). 

8

For additional discussion of these broader fiscal challenges, see GAO, Our Nation’s Fiscal 

Outlook: The Federal Government’s Long-Term Budget Imbalance, at 

http://www.gao.gov/special.pubs/longterm/longterm.html. 
Page 5 GAO-05-772T 

and credit of the U.S. government,9 policymakers would undoubtedly face 

intense pressure to provide PBGC the resources to continue paying earned 

pension benefits to millions of retirees if PBGC were to become insolvent. 

In light of the intrinsic problems facing the defined benefit system, 

meaningful and comprehensive reform will be needed to ensure that 

workers and retirees receive the benefits promised to them and to secure 

PBGC’s financial future. At this time, the Administration, members of 

Congress, and others have proposed reforms that seek to address many of 

the problems facing PBGC and the defined benefit system. This is a 

promising development that can be a critical first step in addressing part 

of the long-term fiscal problems facing this country. 

Before enactment of the Employee Retirement Income Security Act of 

1974 (ERISA), few rules governed the funding of defined benefit pension 

plans, and participants had no guarantees that they would receive their 

promised benefits. Among other things, ERISA created the PBGC to 

protect the benefits of plan participants in the event that plan sponsors 

could not meet the benefit obligations under their plans. ERISA also 

established rules for funding defined benefit pension plans, instituted 

pension insurance premiums, promulgated certain fiduciary rules, and 

developed annual reporting requirements. When a plan is terminated with 

insufficient assets to pay its guaranteed benefits, PBGC takes over the plan 

and assumes responsibility for paying benefits to participants. According 

to PBGC’s 2004 annual report, PBGC provides insurance protection for 

over 29,000 single-employer pension plans, which cover 34.6 million 

workers, retirees, and their beneficiaries.10

PBGC receives no direct federal tax dollars to support the single-employer 

pension insurance program. Instead, the program receives the assets of 

terminated underfunded plans and any of the sponsor’s assets that PBGC 

 9

PBGC is authorized to borrow up to $100 million from the U.S. Treasury to cover 

temporary cash shortfalls. 

10PBGC also guarantees a smaller pension benefit for approximately 10 million participants 

in multiemployer pension plans. 

Background 
Page 6 GAO-05-772T 

recovers during bankruptcy proceedings.11 PBGC finances the unfunded 

liabilities of terminated plans with premiums paid by plan sponsors and 

income earned from the investment of program assets. Premiums have 

two components: a per participant charge paid by all sponsors (currently 

$19 per participant), and a variable-rate premium that some underfunded 

plans pay based on the level of unfunded benefits.12

The single-employer program has had an accumulated deficit—that is, 

program assets have been less than the present value of benefits and other 

obligations—for much of its existence. (See fig. 2.) In fiscal year 1996, the 

program had its first accumulated surplus, and by fiscal year 2000, the 

accumulated surplus had increased to about $10 billion, in 2002 dollars. 

However, the program’s finances reversed direction in 2001, and at the end 

of fiscal year 2002, its accumulated deficit was about $3.6 billion. In fiscal 

year 2004, the single-employer program incurred a net loss of $12.1 billion, 

and its accumulated deficit increased to $23.3 billion, up from $11.2 billion 

a year earlier. Furthermore, PBGC estimated that total underfunding in 

single-employer plans exceeded $450 billion, as of the end of fiscal year 

2004. 

 11According to PBGC officials, PBGC files a claim for all unfunded benefits in bankruptcy 

proceedings. However, PBGC generally recovers only a small portion of the total unfunded 

benefit amount in bankruptcy proceedings, and the recovered amount is split between 

PBGC (for unfunded guaranteed benefits) and participants (for unfunded nonguaranteed 

benefits). 

12The additional premium equals $9.00 for each $1,000 (or fraction thereof) of unfunded 

vested benefits. A plan’s sponsor may be exempt from paying the variable rate premium if 

the plan met a specified funding threshold in the previous plan year. 
Page 7 GAO-05-772T 

Figure 2: Assets, Liabilities, and Net Financial Position of PBGC’s Single-Employer Insurance Program 

In defined benefit plans, formulas set by the employer determine employee 

benefits. DB plan formulas vary widely, but benefits are frequently based 

on participant earnings and years of service, and traditionally paid upon 

retirement as a lifetime annuity, or periodic payments until death. Because 

DB plans promise to make payments in the future, and because taxqualified DB plans must be funded, employers must use present value 

calculations to estimate the current value of promised benefits.13 The 

calculations require making assumptions about factors that affect the 

amount and timing of benefit payments, such as an employee’s retirement 

age and expected mortality, and about the expected return on plan assets, 

expressed in the form of an interest rate. The present value of accrued 

 13Present value calculations reflect the time value of money—that a dollar in the future is 

worth less than a dollar today, because the dollar today can be invested and earn interest. 

Using a higher interest rate will lower the present value of a stream of payments because it 

implies that a lower level of assets today will be able to fund those future payments. 

-30

-20

-10

0

10

20

30

40

50

60

70

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

-30

-20

-10

0

10

20

30

40

50

60

70

Dollars in billions

Source: Pension Benefit Guaranty Corporation.

Fiscal year

Assets

Liabilities

Net position

-23.305
Page 8 GAO-05-772T 

benefits calculated using mandated assumptions is known as a plan’s 

current liability. Current liability provides an estimate of the amount of 

assets a plan needs today to pay for accrued benefits. 

ERISA and the Internal Revenue Code (IRC) prescribe rules regarding the 

assumptions that sponsors must use to measure plan liabilities and assets. 

While different assumptions will change a plan’s reported assets and 

liabilities, sponsors eventually must pay the amount of benefits promised; 

if the assumptions used to compute current liability differ from the plan’s 

actual experience, current liability will differ from the amount of assets 

actually needed to pay benefits.14

Funding rules generally presume that a pension plan and its sponsor are 

ongoing entities, and plans do not necessarily have to maintain an asset 

level equal to current liabilities every year. However, the funding rules 

include certain mechanisms that are intended to keep plans from 

becoming too underfunded. One such mechanism is the additional funding 

charge (AFC), which applies to plans with more than 100 participants.15

The AFC requires plan sponsors to make additional contributions to plans 

that fall below a prescribed funding level. With some exceptions, plans 

with reported asset values below 90 percent of current liabilities are 

affected by the AFC rules. 

 14A plan’s current liability may differ from its termination liability, which measures the 

value of accrued benefits using assumptions appropriate for a terminating plan. For further 

discussion of current versus termination liability, see appendix IV of GAO, Pension Benefit 

Guaranty Corporation: Single-Employer Pension Insurance Program Faces Significant 

Long-Term Risks, GAO-04-90, (Washington, D.C.: Oct. 29, 2003). 

15The AFC was introduced by the Omnibus Budget Reconciliation Act of 1987. See Pub. L. 

No. 100-203 (1987). 
Page 9 GAO-05-772T 

A combination of recent events, long-term structural problems, and 

weaknesses in the legal framework governing the DB system has left 

PBGC with a significant long-term deficit and many large plans badly 

underfunded. Lower interest rates and equity prices since 2000 have 

combined to significantly increase pension underfunding through an 

increase in the present value of pension liabilities, and decreases in the 

value of pension plan assets. Meanwhile, intense cost competition as a 

result of globalization and deregulation has led to bankruptcies of plan 

sponsors in key industries like steel and airlines, and is exposing PBGC to 

the risk of significant future losses in these and other industries. This 

competitive restructuring has occurred simultaneously with a long term 

decline in defined benefit plan participation that threatens PBGC’s 

revenue base. In addition, the basic legal framework governing pension 

insurance and plan funding has failed to safeguard the benefit security of 

American workers and retirees and the PBGC’s financial condition. Too 

many companies are making pension promises that they are not required 

to deliver on, in part because of perverse incentives and “put options” 

created under the current pension insurance system. 

PBGC’s current premium structure does not properly reflect the risks to 

its insurance program and facilitates moral hazard by plan sponsors. 

Further, current pension funding rules have not provided sufficient 

incentives, transparency, and accountability mechanisms for plan 

sponsors to properly fund their benefit obligations and deliver on their 

promises. As a result, bankrupt plan sponsors, acting rationally and within 

the rules, have transferred the obligations of their large and significantly 

underfunded plans to PBGC. These weaknesses in the legal framework 

contribute to and are exacerbated by a lack of transparent information 

that makes it difficult for interested stakeholders to understand the true 

financial condition of and risk associated with selected pension plans. 

Over the last 5 years, many large pension plans have been adversely 

affected by simultaneous declines in broad equity indexes and long-term 

interest rates, as well as by the financial difficulties of their plan 

sponsors.16 Poor investment returns from stock market declines affected 

the asset values of pension plans to the extent that plans invested in 

stocks. According to the ERISA Industry Committee, assets in private 

 16Broad equity indexes in the U.S. have risen since 2002 but remain significantly below their 

peak levels of 2000. 

PBGC’S Problems 

Stem from Recent 

Events, Long-Term 

Structural Trends, and 

Weaknesses in the 

Legal Framework 

Governing DB 

Pensions 

Recent Economic Factors 

Exacerbated the 

Underfunding of Large 

Terminated Plans by 

Bankrupt Sponsors 
Page 10 GAO-05-772T 

sector defined benefit plans totaled $2.056 trillion at the end of 1999, 

dropped to $1.531 trillion at the end of 2002, and climbed back to 

$1.8 trillion by the end of 2004.17 Lower equity values since the end of 1999 

have been particularly problematic because interest rates have also 

declined and thus increased the present value of plan liabilities.18 Some 

sponsors of large pension plans that were terminated were not in 

sufficiently strong financial condition to meet their pension funding 

requirements because of weaknesses in their primary business activities. 

Bankruptcies and pension plan terminations increased around the U.S. 

economic recession of 2001 and around prior recessions.19

These conditions played a part in increasing the unfunded liabilities of 

plans terminated by bankrupt sponsors since 2000. For example, 

according to the filing of its annual regulatory report for pension plans, 

Bethlehem Steel’s plan went from 86 percent funded in 1992 to 97 percent 

funded in 1999. From 1999 to its plan termination in December 2002, plan 

funding fell to less than 50 percent as assets decreased and liabilities 

increased and sponsor contributions were not sufficient to offset the 

changes. 

 17ERISA Industry Committee, Consensus Proposals for Pension Funding, PBGC Reform, 

and Hybrid Pension Plans, (Washington, D.C.: May 2005). Asset totals in 2002 and 2004 

include billions of dollars in contributions by plan sponsors since 1999. 

18Falling interest rates raise the price of group annuities that a terminating plan must 

purchase to cover its promised benefits and increase the likelihood that a terminating plan 

will not have sufficient assets to make such a purchase. A potentially offsetting effect of 

falling interest rates is the possible increased return on fixed-income assets that plans hold. 

When interest rates fall, the value of existing fixed-income securities with time left to 

maturity rises. 

19Three of the last five annual increases in bankruptcies coincided with recessions, and the 

record economic expansion of the 1990s is associated with a substantial decline in 

bankruptcies. Annual plan terminations resulting in losses to the single-employer program 

rose from 83 in 1989 to 175 in 1991, and after declining to 65 in 2000, the number reached 93 

in 2001. The last three recessions on record in the United States occurred during 1981, 

1990-91, and 2001 (See www.bea.gov/bea/dn/gdpchg.xls). 
Page 11 GAO-05-772T 

Long-term trends in some sectors of the economy and in defined benefit 

pension coverage are threatening both PBGC’s future solvency and the 

economic security in retirement of workers and retirees. PBGC’s risk of 

inheriting underfunded pensions largely stems from the fact that more 

than half of the pension participants it insures are in the manufacturing 

and airline sectors, which have been exposed to lower cost competition 

because of several factors including globalization and deregulation.20 A 

potentially exacerbating risk to PBGC is the cumulative effect of 

bankruptcy in these industries: if a critical mass of firms go bankrupt and 

terminate their underfunded pension plans, their competitors may also 

declare bankruptcy to similarly avoid the cost of funding their plans. 

PBGC also faces the possibility of long-term revenue declines from 

demographic changes in the population of defined benefit plan 

participants and a shrinking number of DB plans. Over the long term, an 

aging population of defined benefit plan participants threatens to reduce 

PBGC’s ability to raise premium revenues as participants die and are not 

replaced by enough new participants. The percentage of participants who 

are active workers has declined from 78 percent in 1980 to just under 50 

percent in 2002. Furthermore, PBGC cannot effectively diversify its risk 

from the terminations of plans in declining economic sectors because 

companies in other growing industries have generally not sponsored new 

defined benefit plans. As plan sponsors in weak industries go bankrupt 

and terminate their pension plans, PBGC not only faces immediate 

changes in its financial position from taking over underfunded plans, but 

also faces losses of future revenues from these terminated plans. 

A related factor eroding PBGC’s premium base is the growth of lump-sum 

pension distributions. More and more plan participants are exiting the 

defined benefit system by taking lump-sum distributions from their plans. 

After a lump-sum distribution is paid, the participant is out of the defined 

benefit system and the plan sponsor no longer has to contribute to the 

pension insurance system on the participant’s behalf. In addition, lumpsum distributions to participants in underfunded plans can create the 

effect of a “run on the bank” and worsen a plan’s underfunding. In such 

 20The causes of restructuring are likely industry-specific. For example, the U.S. airline 

industry, which has many pension plans in poor financial condition, has faced profit 

pressures as a result of severe price competition, terrorism, the war in Iraq, and the 

outbreak of severe acute respiratory syndrome (SARS), creating bankruptcies and 

uncertainty about the future financial health of the industry. 

Long-Term Declines of Key 

Industries and in Defined 

Benefit Pension Coverage 

Have Contributed to 

PBGC’s Weakening 

Financial Condition 
Page 12 GAO-05-772T 

cases, the plan may terminate without enough assets to pay full benefits to 

other participants and PBGC may incur losses. 

The increasing prevalence of lump-sum distributions in defined benefit 

plans and the growth of defined contribution plans also raise significant 

questions about whether many Americans will enjoy an economically 

secure retirement.21 Many Americans are at risk of outliving their 

retirement assets as life expectancies, health care, and long-term care 

costs continue to increase. 

Existing laws and regulations governing pension funding and premiums 

have contributed to PBGC’s financial difficulties and exposed PBGC to 

greater risks from the companies whose pension plans it insures. PBGC’s 

current premium structure does not properly reflect the risks to its 

insurance program and facilitates moral hazard by plan sponsors. Further, 

the pension funding rules, under ERISA and the IRC, have not ensured that 

plans have the means to meet their benefit obligations in the event that 

plan sponsors run into financial distress. First, the current rules likely 

allowed plans to appear better funded than they actually were, in both 

good years and bad years. And even these reported funding levels 

indicated significant levels of underfunding in our study of the 100 largest 

DB plans.22 Second, plan sponsors often substituted “account credits” for 

cash contributions, even as the market value of plan assets may have been 

in decline. And third, the AFC, the primary mechanism for improving the 

financial condition of poorly funded plans, was ineffective in doing so. 

These weaknesses contribute to and are exacerbated by a lack of 

transparent information that makes it difficult for plan participants, 

investors, and others to have a clear understanding of their plan’s financial 

condition. As a result, financially weak benefit plan sponsors, acting 

rationally and within the current law, have been able to avoid large 

contributions to underfunded plans prior to bankruptcy and plan 

termination, thus adding to PBGC’s current deficit. 

 21A major factor contributing to the increase in lump-sum distributions from defined benefit 

plans is the growing prevalence of hybrid plans, such as cash balance plans, which typically 

offer lump sums. Hybrid plans are a form of DB plan that determines benefits on the basis 

of hypothetical individual accounts. 

22 GAO-05-294. 

Legal Framework Has Not 

Encouraged Adequate Plan 

Funding, Contributing to 

PBGC’s Financial 

Difficulties 
Page 13 GAO-05-772T 

PBGC’s current premium structure does not properly reflect risks to the 

insurance program. The current premium structure relies heavily on flatrate premiums, which, since they are unrelated to risk, result in large cost 

shifting from financially troubled companies with underfunded plans to 

healthy companies with well-funded plans. PBGC also charges plans a 

variable-rate premium based on the plan’s level of underfunding. However, 

these premiums do not consider other relevant risk factors, such as the 

economic strength of the sponsor, plan asset investment strategies, the 

plan’s benefit structure, or the plan’s demographic profile. PBGC is 

currently operated somewhat more on a social insurance model, since it 

must cover all eligible plans regardless of their financial condition or the 

risks they pose to the solvency of the insurance program. 

In addition to facing firm-specific risk that an individual underfunded plan 

may terminate, PBGC faces market risk that a poor economy may lead to 

widespread underfunded terminations during the same period, potentially 

causing very large losses for PBGC. Similarly, PBGC may face risk from 

insuring plans concentrated in vulnerable industries affected by certain 

macroeconomic forces such as deregulation and globalization that have 

played a role in multiple bankruptcies over a short time period, as has 

happened recently in the airline and steel industries. One study estimates 

that the overall premiums collected by PBGC amount to about 50 percent 

of what a private insurer would charge because its premiums do not 

adequately account for these market risks.23 Others note that it would be 

hard to determine the market-rate premium for insuring private pension 

plans because private insurers would probably refuse to insure poorly 

funded plans sponsored by weak companies. 

Current pension funding and insurance laws create incentives for 

financially troubled firms to use PBGC in ways that Congress likely did not 

intend when it formed the agency in 1974. At that time, PBGC was 

established to pay the pension benefits of participants, subject to certain 

limits, in the event that an employer could not. However, since that time, 

some firms with underfunded pension plans may have come to view PBGC 

coverage as a fallback, or “put option,” for financial assistance. The very 

presence of PBGC insurance may create certain perverse incentives that 

represent what economists call moral hazard—where struggling plan 

sponsors may place other financial priorities above funding up their 

 23Boyce, Steven, and Richard A. Ippolitio, “The Cost of Pension Insurance,” The Journal of 

Risk and Insurance, (2002) Vol. 69, No. 2, pp.121-170. 

PBGC’s Premium Structure 

Does Not Properly Reflect 

Risks to the Insurance Program 

PBGC Is Subject to Moral 

Hazard 
Page 14 GAO-05-772T 

pension plans because they know PBGC will pay guaranteed benefits. 

Firms may even have an incentive to seek Chapter 11 bankruptcy in order 

to escape their pension obligations. As a result, once a plan sponsor with 

an underfunded pension plan experiences financial difficulty, these moral 

hazard incentives may exacerbate the funding shortfall for PBGC. 

This moral hazard effect has the potential to escalate, with the initial 

bankruptcy of firms with underfunded plans creating a vicious cycle of 

bankruptcies and terminations. Firms with onerous pension obligations 

and strained finances could see PBGC as a means of shedding these 

liabilities, thereby providing these companies with a competitive 

advantage over other firms that deliver on their pension commitments. 

This would also potentially subject PBGC to a series of terminations of 

underfunded plans in the same industry, as we have already seen with the 

steel and airlines industries in the past 20 years. 

Moral hazard effects are likely amplified by current pension funding and 

pension accounting rules that may also encourage plans to invest in riskier 

assets to benefit from higher expected long-term rates of return. In 

determining funding requirements, a higher expected rate of return on 

pension assets means that the plan needs to hold fewer assets in order to 

meet its future benefit obligations. And under current accounting rules, 

the greater the expected rate of return on plan assets, the greater the plan 

sponsor’s operating earnings and net income. However, with higher 

expected rates of return comes greater risk of investment volatility, which 

is not reflected in the pension insurance program’s premium structure. 

Investments in riskier assets with higher expected rates of return may 

allow financially weak plan sponsors and their plan participants to benefit 

from the upside of large positive returns on pension plan assets without 

being truly exposed to the risk of losses. The benefits of plan participants 

are guaranteed by PBGC, and weak plan sponsors that enter bankruptcy 

can often have their plans taken over by PBGC. 

The pension funding rules, under ERISA and the IRC, have not provided 

sufficient incentives for plan sponsors to properly fund their benefit 

obligations. The funding rules generally presume that pension plans and 

their sponsors are ongoing entities and therefore allow for a certain extent 

of plan underfunding that can be made up over time. However, the 

measures of plan funding used to determine contribution requirements can 

significantly overstate the true financial condition of a plan. And even 

Current Funding Rules Do Not 

Provide Sufficient Incentives 

for Sponsors to Adequately 

Fund Their Plans 
Page 15 GAO-05-772T 

these reported funding levels indicated significant levels of underfunding 

in our study of the 100 largest DB plans.24 Furthermore, when plan 

sponsors make contributions to their plans, they can use account credits, 

rather than cash, even in cases when plans are underfunded. The funding 

rules include certain mechanisms—primarily, the AFC—that are intended 

to prevent plans from becoming too underfunded. However, our analysis 

shows that for several reasons, the AFC proved ineffective in restoring 

financial health to poorly funded plans. 

Rules May Allow Plans to Overstate Their Current Funding Levels 

Current funding rules may allow plans to overstate their current funding 

levels to plan participants and the public. Because many plans in our 

sample chose legally allowable actuarial assumptions and asset valuation 

methods that may have altered their reported liabilities and assets relative 

to market levels, it is possible that funding over our sample period was 

actually worse than reported. 

Although as a group, funding levels among the 100 largest plans were 

reasonably stable and strong from 1996 to 2000, by 2002, more than half of 

the largest plans were underfunded (see fig. 3). On average, each year 39 

of these plans were less than 100 percent funded, 10 had assets below 

90 percent of their current liabilities, and 3 plans were less than 80 percent 

funded. In 2002 there were 23 plans less than 90 percent funded. 

 24For further details of this study, covering 1995-2002, see GAO-05-294. These 100 plans are 

not a closed group. The 100 largest plans, as measured by current liability, changed from 

year to year for various reasons, including mergers and divestitures of plan sponsors. A 

total of 187 distinct plan identifiers were included in our sample, and 25 of them were in 

each year’s sample. 
Page 16 GAO-05-772T 

Figure 3: Almost One-Fourth of the Largest Pension Plans Were Less than 90 

Percent Funded on a Current Liability Basis in 2002 

Reported funding levels may have been overstated for a number of 

reasons. These include the use of above-market interest rates, which leads 

to an understatement of the cost of settling benefit obligations through the 

purchase of group annuity contracts. Also, actuarial asset values may have 

differed by as much as 20 percent from current market value of plan 

assets. The funding rules allow for smoothing out year-to-year fluctuations 

in asset and liability values so that plan sponsors are gradually, and not 

suddenly, affected by significant changes in interest rates and the values of 

their assets. When current interest rates decline, the use of a 4-year 

weighted average interest rate lags behind, and thus measurements of the 

0

20

40

60

80

100

1995 1996 1997 1998 1999 2000 2001 2002

Percentage of 100 largest DB plans

Source: GAO analysis of PBGC Form 5500 research data.

Year

Less than 80% funded 

80% to less than 90% funded

90% to less than 100% funded

100% to less than 110% funded

110% funded or above
Page 17 GAO-05-772T 

present value of plan liabilities do not accurately reflect the cost of settling 

a plan’s benefit obligations.25

The terminations of the Bethlehem Steel and LTV Steel pension plans in 

2002 (two of the largest plan terminations, to date) illustrate the potential 

discrepancies between reported and actual funding. In 2002, the 

Bethlehem Steel Corporation reported that its plan was 85.2 percent 

funded on a current liability basis, yet the plan terminated later that year 

with assets of less than half of the value of promised benefits. In 2001, LTV 

Steel reported that its plan for hourly employees was 80 percent funded, 

yet when the plan terminated in March 2002, it was only 52 percent 

funded. From these terminations PBGC’s single-employer program 

suffered losses of $3.7 billion and $1.6 billion, respectively.26 

Most Sponsors Most Years Made No Cash Contributions to Plans 

but Satisfied Funding Requirements through Use of Accounting 

Credits 

The amount of contributions required under IRC minimum funding rules is 

generally the amount needed to fund benefits earned during that year plus 

that year’s portion of other liabilities that are amortized over a period of 

years. This minimum contribution requirement may be met by the plan 

sponsor putting cash into the plan or by applying earned funding credits. 

These funding credits are not measured at their market value and are 

credited with interest each year, according to the plan’s long-term 

expected rate of return on assets.27 When the market value of a plan’s 

assets declines, the value of funding credits may be significantly 

overstated. 

 25Conversely, when interest rates rise, the opposite would be true, and the weighted 

average would make the cost of settling plan liabilities higher than the current market rate 

would indicate. 

26Several factors may explain the wide discrepancy between reported funding levels and 

actual funding levels at termination. Reported funding levels may use an actuarial value of 

assets, which may exceed the market value at termination. In addition, termination 

liabilities are valued using a different interest rate than that used for current liabilities. 

Further, current liabilities and termination liabilities may be measured at different times. 

Unfunded shutdown benefits may also raise termination liabilities. For more discussion of 

the differences between termination and current liabilities, see GAO-04-90, appendix IV. 

27See 26 U.S.C. 412(b). 
Page 18 GAO-05-772T 

For the 1995 to 2002 period, the sponsors of the 100 largest plans each 

year on average made relatively small cash contributions to their plans 

(see fig. 4). Annual cash contributions for the 100 largest plans averaged 

approximately $97 million on plans averaging $5.3 billion in current 

liabilities (in 2002 dollars). This average contribution level masks a large 

difference in contributions between 1995 and 2001, during which period 

annual contributions averaged $62 million (in 2002 dollars), and in 2002, 

when contributions increased significantly to $395 million per plan. 

Further, in 6 of the 8 years in our sample, a majority of the largest plans 

made no cash contribution to their plan. On average each year, 62.5 plans 

received no cash contribution, including an annual average of 41 percent 

of plans that were less than 100 percent funded. 

Figure 4: Most Large Plans Received No Annual Cash Contribution, 1995–2002 

Note: Average contributions for 2002 are largely driven by one sponsor’s contribution to its plan. 

Disregarding this $15.2 billion contribution reduces the average plan contribution for 2002 from $395 

million to $246 million. 

As stated earlier, Bethlehem Steel and LTV Steel both had plans terminate 

in 2002 that were only about 50 percent funded. Yet each plan was able to 

forgo a cash contribution each year from 2000 to 2002, instead using 

credits to satisfy minimum funding obligations, primarily from large 
Page 19 GAO-05-772T 

accumulated credit balances from prior years. Despite being severely 

underfunded, each plan reported an existing credit balance at the time of 

termination. 

AFC, Primary Mechanism for Improving Funding of Underfunded 

Plans, Proved Ineffective 

The funding rules’ primary mechanism for improving the financial 

condition of underfunded plans, the additional funding charge proved 

ineffective in helping underfunded plans for four main reasons: 

1. Very few plans in our sample were actually assessed an AFC because 

the rules, despite the statutory threshold of a 90 percent funding level 

for some plans to owe an AFC, in practice require a plan to be much 

more poorly funded to be subject to this requirement.28 From 1995 to 

2002, an average of only 2.9 of the 100 largest DB plans each year were 

assessed an additional funding charge, even though on average 10 

percent of plans each year reported funding levels below 90 percent. 

Over the entire 8-year period, only 6 unique plans that were among the 

100 largest plans in any year from 1995 to 2002 owed an AFC. These 6 

plans owed an AFC during the period a total of 23 times in years in 

which they were among the 100 largest plans, meaning that plans that 

were assessed an AFC were likely to owe it again. 

2. AFC rules also specify a current liability calculation method that may 

overstate actual plan funding, relative to market-value measures, 

thereby reducing the number of plans that might be assessed an AFC. 

The specified interest rate for this calculation exceeded current 

market rates in 98 percent of the months between 1995 and 2002. 

3. The AFC rules generally call for sponsors to pay only a percentage of 

their unfunded liability, rather than requiring restoration of full 

funding. On average, by the time a plan was assessed an AFC, it was 

significantly underfunded and was likely to remain chronically 

underfunded in subsequent years. Among the 6 plans that owed the 

AFC, funding levels rose slightly from an average of 75 percent when 

the plan was first assessed an AFC to an average of 76 percent, looking 

collectively at all subsequent years. All of these plans were assessed an 

AFC more than once. 

 28A plan is not subject to an AFC if the value of plan assets (1) is at least 80 percent of 

current liability and (2) was at least 90 percent of current liability for at least 2 consecutive 

of the 3 immediately preceding years. 
Page 20 GAO-05-772T 

4. Plan sponsors can meet the AFC requirement by applying funding 

credits earned in prior years in place of cash contributions. The 

account value of these credits, which accumulate interest, may not 

reflect the underlying value of the assets in the plan. Many plans 

experienced significant market value losses of their assets between 

2000 and 2002 while they were able to apply these funding credits. 

Among the 100 largest plans, just over 30 percent of the time a plan 

was assessed an AFC, the funding rules allowed the sponsor to forgo a 

cash contribution altogether that year. 

The experience of two large terminated plans illustrates the 

ineffectiveness of the AFC. For example, Bethlehem Steel’s plan was 

assessed an AFC of $181 million in 2002, but the company made no cash 

contribution that year, just as it had not in 2000 or 2001, years in which the 

plan was not assessed an AFC. When the plan terminated in late 2002, its 

assets covered less than half of the $7 billion in promised benefits. LTV 

Steel, which terminated its pension plan for hourly employees in 2002 with 

assets of $1.6 billion below the value of benefits, had its plan assessed an 

AFC each year from 2000 to 2002, but for only $2 million, $73 million, and 

$79 million, or no more than 5 percent of the eventual funding shortfall. 

Despite these AFC assessments, LTV Steel made no cash contributions to 

its plan from 2000 to 2002. Both plans were able to apply existing credits 

instead of cash to satisfy minimum funding requirements. In addition, both 

sponsors had unused funding credits at the time their plans were 

terminated. 

Unclear measures of pension funding and a lack of timely information 

have made it difficult for plan participants, investors, regulators, and 

policy makers to accurately assess the financial condition of pension 

plans. Without timely and reasonably accurate data about the financial 

condition of pension plans, the various stakeholders cannot make timely 

and informed decisions on retirement savings, employment, and other key 

life issues. The primary regulatory filing for pension plans—the Form 

5500--requires multiple measures of pension assets and liabilities, yet none 

of these measures tell PBGC and plan participants what share of the 

benefit obligations are funded in the event of plan termination. 

Furthermore, by the time these regulatory reports are publicly available, 

Weaknesses in Funding Rules 

Amplified by Lack of 

Transparency Hinders Sound 

Policy making 
Page 21 GAO-05-772T 

the information is usually at least 2 years old.29 In a time of significant 

changes in interest rates and equity prices, it is possible that reported 

measures of pension funding will substantially differ from current 

measures of plan funding. PBGC does receive more current information 

about plans that are underfunded by at least $50 million. This more current 

information includes estimates of funding measures if the plan were to be 

terminated; however, by law this information is not disclosed to the 

public. 

Our cash-based budgetary framework for federal insurance programs also 

contributes to a lack of transparency that, at worst, may create 

disincentives for policy makers to enact reform measures.30 With the 

current cash-based reporting, premiums for insurance programs are 

recorded in the budget when collected, and outlays are reported when 

claims are paid.31 This focus on annual cash flows generally does not 

adequately reflect the government’s cost for federal insurance programs 

because the time between the extension of the insurance, the receipt of 

premiums and other collections, the occurrence of an insured event, and 

the payment of claims may extend over several budget periods. As a result, 

the government’s cost may be understated in years that a program’s 

current premium and other collections exceed current payments and 

overstated in years that current claim payments exceed current 

collections. This is especially problematic in the case of pension insurance 

because of the erratic occurrence of plan terminations as well as the 

 29For further information about problems with the content and timeliness of regulatory 

reports on pensions, see GAO, Private Pensions: Government Actions Could Improve the 

Timeliness and Content of Form 5500 Pension Information, GAO-05-491 (Washington, 

D.C.: June 3, 2005), and Private Pensions: Publicly Available Reports Provide Useful but 

Limited Information on Plans’ Financial Condition, GAO-04-395 (Washington, D.C.: Mar. 

31, 2004). 

30GAO, Budget Issues: Budgeting for Federal Insurance Programs, GAO/T-AIMD-98-147

(Washington, D.C.: Apr. 23, 1998), and Budget Issues: Budgeting for Federal Insurance 

Programs, GAO/AIMD-97-16 (Washington, D.C.: Sept. 30, 1997). 

31PBGC's premium collections and benefit payments are recorded in the budget on a cash 

basis, regardless of when the commitments are made. The premiums paid by participants 

are held in a revolving fund. PBGC's budget treatment is complicated by the use of a 

second account for some activities which is not included in the federal budget. This 

account records the assets and liabilities that PBGC acquires from terminated plans. As a 

result, the budget only reports PBGC's net annual cash flows between its on-budget 

account and all other entities, including the other PBGC account. It does not provide 

information on liabilities PBGC incurs when it takes over an underfunded plan or other 

changes in PBGC's assets and liabilities. 
Page 22 GAO-05-772T 

mismatch between premium collections and benefit payments that can 

extend over several decades. 

Cash-based budgeting also may not be a very accurate gauge of the 

economic impact of federal insurance programs. Although discerning the 

economic impact of federal insurance programs can be difficult, private 

economic behavior generally is affected when the government commits to 

providing insurance coverage. In the case of PBGC, the existence of 

pension insurance may encourage plan sponsors and employees to agree 

to pension benefit increases in lieu of wage increases when the plan 

sponsor faces economic difficulties.32

Cash-based budgeting for federal insurance programs may provide neither 

the information nor incentives necessary to signal emerging problems, 

make adequate cost comparisons, control costs, or ensure the availability 

of resources to pay future claims. Because the cash-based budget delays 

recognition of emerging problems, it may not provide policy makers with 

information or incentives to address potential funding shortfalls before 

claim payments come due. Policy makers may not be alerted to the need to 

address programmatic design issues because, in most cases, the budget 

does not encourage them to consider the future costs of federal insurance 

commitments. Thus, reforms aimed at reducing costs may be delayed. In 

most cases, by the time costs are recorded in the budget, policy makers do 

not have time to ensure that adequate resources are accumulated to pay 

for them or to take actions to control them. The late budget recognition of 

these costs can reduce the number of viable options available to policy 

makers, ultimately increasing the cost to the government. 

In light of the intrinsic problems facing the defined benefit system, 

meaningful and comprehensive pension reform is required to ensure that 

workers and retirees receive the benefits promised to them and to secure 

PBGC’s financial future. While PBGC’s current financial condition does 

not represent a crisis, delaying reform will result in serious adverse 

consequences for plan participants, the federal budget, and our nation’s 

economy. At this time, the Administration, members of Congress, and 

others have proposed reforms that seek to address many of the problems 

 32GAO-05-578SP. 

Retirement Income 

Security Requires 

Meaningful and 

Comprehensive 

Reform 
Page 23 GAO-05-772T 

facing PBGC and the defined benefit system.33 Such comprehensive 

effective pension reform would likely include elements that would 

improve measures of pension funding and enhance transparency of plan 

information, strengthen funding rules (while preserving some contribution 

flexibility for plan sponsors, modify certain PBGC guarantees, develop an 

enhanced and more risk-based insurance premium structure, and resolve 

outstanding controversies concerning hybrid plans, such as cash balance 

plans.34

Pension reform is a challenge because of the necessity of fusing together 

so many complex, and sometimes competing, elements into a 

comprehensive proposal. Ideally, effective reform would 

• improve the accuracy of plan funding measures while minimizing 

complexity and maintaining contribution flexibility; 

• revise the current funding rules to create incentives for plan sponsors to 

adequately finance promised benefits; 

• develop a more risk-based PBGC insurance premium structure and 

provides incentives for sponsors to fund plans adequately; 

• address the issue of underfunded plans paying lump sums and granting 

benefit increases; 

• modify PBGC guarantees of certain plan benefits (e.g., shutdown benefits); 

• resolve outstanding controversies concerning hybrid plans by 

safeguarding the benefits of workers regardless of age; and 

• improve plan information transparency for pension plan stakeholders 

without overburdening plan sponsors. 

 33For example, earlier this year, the Administration released a proposal that focuses on 

reforming the funding rules; improving disclosure to workers, investors, and regulators 

about pension plan status; and adjusting premiums to better reflect a plan’s risk to PBGC. 

See U.S. Department of Labor, Employee Benefits Security Administration, Strengthen 

Funding for Single Employer Pension Plans, February 7, 2005. 

34For greater detail, see GAO-04-90. 

GAO Has Suggested 

Elements of Pension 

Reform 
Page 24 GAO-05-772T 

Furthermore, if policy makers decide to provide measures of relief to 

sponsors of poorly funded pension plans, there should be mechanisms 

built into such laws that would prevent any undue exacerbation of PBGC’s 

financial condition. 

Developed in isolation, solutions to some of these concerns could erode 

the effectiveness of other reform components or introduce needless 

complexity. As deliberations on reform move forward, it will be important 

that each of these individual elements be designed so that all work in 

concert toward well-defined goals. Even with meaningful, carefully crafted 

reform, it is possible that some defined benefit plan sponsors may choose 

to freeze or terminate their plans. While these are serious concerns, the 

overarching goals of balanced pension reform should be to protect 

workers’ benefits by providing employers the flexibility they need in 

managing their pension plans while also holding those employers 

accountable for the promises they make to their employees. 

The debate over defined benefit pension reform should not take place in 

isolation of larger related issues. Challenges in the defined benefit system, 

together with the recent public debate over the merits of including 

individual accounts as part of a more comprehensive Social Security 

reform proposal, should lead us to consider fundamental questions about 

how who should bear certain risks and responsibilities for economic 

security in retirement. 

• Individual savings require greater responsibility and offer greater potential 

rewards and the possibility of bequeathing any unused retirement savings. 

However, longevity risk—the risk of outliving retirement savings—and 

poor investment choice are significant concerns, particularly as health 

care and long-term care costs and life expectancies continue to rise. 

• The federal government is in the best position to share risk across the 

population, and social insurance programs, including Social Security, 

Medicare, and Medicaid already reflect this fact. However, the current 

structure of existing federal retirement programs is unsustainable. 

• Employer-sponsored pensions can alleviate longevity risk for plan 

participants and are generally presumed to be better placed to manage 

investment risk. However, poor management of plans can lead to shortfalls 

in funding that can damage the competitiveness of the plan sponsors. 

Furthermore, many employers are cutting or reducing retiree health 

benefits, and even employee health benefits, as growing health care costs 

threaten their competitiveness. 
Page 25 GAO-05-772T 

Earlier this year, GAO convened a forum on the future of the defined 

benefit system and the PBGC that included a diverse group of about 40 

pension experts, representing various interests, to discuss various reforms 

to the defined benefit pension system.35 In addition to debating changes to 

the funding rules and PBGC premiums, participants also talked about 

ways to address pension legacy costs (the costs of terminated and 

underfunded pension plans) and features of pension plans that 

government policy should encourage. 

According to participants in the GAO forum, resolution of pension legacy 

costs and clarification of the legal status of cash balance and other hybrid 

pension plans could play a significant role in shoring up the defined 

benefit system.36 Separating legacy costs from the existing and future 

liabilities of the remaining defined benefit plans might encourage plan 

sponsors to remain in the defined benefit system. Many plan sponsors are 

concerned that through increased PBGC premiums, they may be required 

to pay for the failures of other companies to responsibly fund and manage 

their pension plans. Some participants added that resolving legacy costs 

could be a key component of any pension reform legislation that tightened 

the funding rules and assessed premiums according to PBGC’s risk. Also, 

some participants supported, and other participants opposed, the idea of 

separately addressing the pension legacy costs of specific industries, such 

as airlines and steel, which have imposed the most significant costs on 

PBGC. Separately addressing pension legacy costs does not necessarily 

imply a taxpayer bailout, as some participants suggested other ways to 

cover their cost, such as through an airline ticket fee to cover the airlines’ 

share of PBGC’s deficit. Others noted that resolving the uncertain legal 

status of cash balance and other hybrid pension plans could encourage 

greater participation in the defined benefit system. Expanding the universe 

 35GAO, Comptroller General’s Forum: The Future of the Defined Benefit System and the 

Pension Benefit Guaranty Corporation, GAO-05-578SP (Washington, DC: June 2005). 

Participants included government officials, researchers, accounting experts, actuaries, plan 

sponsor and employee group representatives, and members of the investment community. 

36Cash balance plans are a type of defined benefit plan that look more like a defined 

contribution plan to participants. As with other defined benefit plans, the sponsor is 

responsible for managing the plan’s commingled assets and complying with the minimum 

funding requirements. However, information about benefits is communicated to plan 

participants through the use of hypothetical account balances, which makes the plan 

appear like an individual account-based defined contribution plan. The hypothetical 

account balances communicated to plan participants do not necessarily bear any 

relationship to actual assets held by the plan. 

Experts Identified a 

Variety of Broad Pension 

Reforms 
Page 26 GAO-05-772T 

of pension plan sponsors could lead to an increase in PBGC’s premium 

income. 

Some forum participants also suggested that the debate over federal 

retirement policy needs to move beyond distinctions between defined 

benefit and defined contribution plans. Others added that discussions of 

retirement policy need to focus on ways to create incentives and remove 

barriers for employers to set up retirement plans, and how to get American 

workers to build adequate retirement savings and security. This may be 

achieved by thinking about the interaction of private pensions and Social 

Security and by looking at hybrid pension plans, such as cash balance 

plans and plans that combine the best features of defined benefit and 

defined contribution plans. Participants suggested new pension plan 

designs be developed that explore the following features: 

• allowing automatic participation of the covered population in order to 

expand pension coverage generally; 

• improving the portability of pension benefits to accommodate workers 

who frequently change jobs; 

• providing for professional money management and pooled investment 

risk; 

• minimizing early withdrawals and borrowing—a problem known as 

leakage—from retirement savings; and 

• providing incentives to receive benefits in the form of a fixed annuity, 

rather than a lump-sum distribution. 

Widely reported recent large plan terminations by bankrupt sponsors and 

the resulting adverse consequences for plan participants and the PBGC 

have pushed pension reform into the spotlight of national concern. Our 

analysis here suggests that a variety of factors have contributed to the 

current state of affairs: recent declines in interest rates and financial 

markets, a soft economy, industry restructuring because of changes in the 

national and world economies, weaknesses in the legal framework 

governing pensions that has encouraged moral hazard by sponsors, the 

underfunding of plans, and a lack of timely, accurate, useful and 

transparent information that limits participants, unions, investors and 

other stakeholders from being able to make accurate and timely decisions. 

Conclusions 
Page 27 GAO-05-772T 

In light of the intrinsic problems facing the defined benefit system, 

meaningful and comprehensive pension reform is required to ensure that 

workers and retirees receive the benefits promised to them. At this time, 

the Administration, members of Congress, and others have proposed 

reforms that seek to address many of the problems facing PBGC and the 

defined benefit system. This is a promising development that can be a 

critical first step in addressing part of the long-term fiscal problems facing 

this country. Such reform will demand wisdom and patience, given the 

necessity of fusing together so many complex, and sometimes competing, 

elements into a comprehensive proposal. Ideally, effective reform would 

• improve the accuracy of plan funding measures while minimizing 

complexity and maintaining contribution flexibility; 

 

• revise the current funding rules to create incentives for plan sponsors to 

adequately finance promised benefits; 

• develop a more risk-based PBGC insurance premium structure and 

provides incentives for sponsors to fund plans adequately; 

• address the issue of underfunded plans paying lump sums and granting 

benefit increases; 

• modify PBGC guarantees of certain plan benefits (e.g., shutdown benefits); 

• resolve outstanding controversies concerning hybrid plans by 

safeguarding the benefits of workers regardless of age; and 

• improve plan information transparency for pension plan stakeholders 

without overburdening plan sponsors. 

However, it is also necessary to keep in mind that pension reform is only 

part of the broader fiscal, economic, workforce, and retirement security 

challenges facing our nation. If you look ahead in the federal budget, 

Social Security, together with the rapidly growing health programs 

(Medicare and Medicaid), will dominate the federal government’s future 

fiscal outlook. These are far larger and more urgent challenges, 

representing an unsustainable burden on future generations. Furthermore, 

pension reform should be considered in the context of the problems facing 

our nation's Social Security system. How we reform DB pensions has 

crucial implications for directions taken in reforming Social Security. For 

example, pension reforms that reduce the scope of the private pension 

system or change the dominant form of private pension design may have 
Page 28 GAO-05-772T 

consequences for those elements of Social Security reform packages that 

reduce benefits or include an individual accounts feature. 

This also means that acting sooner rather than later will make reform less 

costly and more feasible. Though smaller in scale than actuarial deficits in 

Social Security, Medicare, and Medicaid, PBGC’s deficit threatens to 

worsen our government’s long-term fiscal position. Finally, as with Social 

Security, it is also important to evaluate pension reform proposals as 

comprehensive packages. The elements of any reform proposal interact; 

every package will have pluses and minuses, and no plan will satisfy 

everyone on all dimensions. If we focus on the pros and cons of each 

element of reform by itself, we may find it impossible to build the bridges 

necessary to achieve consensus. 

We look forward to working with Congress on these crucial issues. 

Mr. Chairman, this concludes my statement. I would be happy to respond 

to any questions you or other members of the Committee may have. 

For further information, please contact Barbara Bovbjerg at (202) 512-

7215. Individuals making key contributions to this testimony include 

David Eisenstadt and Charlie Jeszeck. 

Contact and 

Acknowledgments 

(130495) 
This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately. 
The Government Accountability Office, the audit, evaluation and 

investigative arm of Congress, exists to support Congress in meeting its 

constitutional responsibilities and to help improve the performance and 

accountability of the federal government for the American people. GAO 

examines the use of public funds; evaluates federal programs and policies; 

and provides analyses, recommendations, and other assistance to help 

Congress make informed oversight, policy, and funding decisions. GAO’s 

commitment to good government is reflected in its core values of 

accountability, integrity, and reliability. 

The fastest and easiest way to obtain copies of GAO documents at no cost 

is through GAO’s Web site (www.gao.gov). Each weekday, GAO posts 

newly released reports, testimony, and correspondence on its Web site. To 

have GAO e-mail you a list of newly posted products every afternoon, go 

to www.gao.gov and select “Subscribe to Updates.” 

The first copy of each printed report is free. Additional copies are $2 each. 

A check or money order should be made out to the Superintendent of 

Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 

more copies mailed to a single address are discounted 25 percent. Orders 

should be sent to: 

U.S. Government Accountability Office 

441 G Street NW, Room LM 

Washington, D.C. 20548 

To order by Phone: Voice: (202) 512-6000 

TDD: (202) 512-2537 

Fax: (202) 512-6061 

Contact: 

Web site: www.gao.gov/fraudnet/fraudnet.htm 

E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470 

Gloria Jarmon, Managing Director, JarmonG@gao.gov (202) 512-4400 

U.S. Government Accountability Office, 441 G Street NW, Room 7125 

Washington, D.C. 20548 

Paul Anderson, Managing Director, AndersonP1@gao.gov (202) 512-4800 

U.S. Government Accountability Office, 441 G Street NW, Room 7149 

Washington, D.C. 20548 

GAO’s Mission 

Obtaining Copies of 

GAO Reports and 

Testimony 

Order by Mail or Phone 

To Report Fraud, 

Waste, and Abuse in 

Federal Programs 

Congressional 

Relations 

Public Affairs 

PRINTED ON RECYCLED PAPER