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23–367—PDF 2005

S. HRG. 109–125

FINANCIAL STATUS OF THE PENSION BENEFIT

GUARANTY CORPORATION AND THE ADMINISTRATION’S DEFINED BENEFIT PLAN FUNDING

PROPOSAL

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

MARCH 1, 2005

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Grassley, Hon. Charles E., a U.S. Senator from Iowa, chairman, Committee

on Finance ............................................................................................................ 1

Baucus, Hon. Max, a U.S. Senator from Iowa ....................................................... 3

ADMINISTRATION WITNESSES

Belt, Hon. Bradley D., Executive Director, Pension Benefit Guaranty Corporation, Washington, DC ........................................................................................... 6

Warshawsky, Hon. Mark J., Assistant Secretary for Economic Policy, Department of the Treasury, Washington, DC ............................................................. 8

Combs, Hon. Ann, Assistant Secretary, the Employee Benefits Security Administration, Department of Labor, Washington, DC ....................................... 10

PUBLIC WITNESSES

Zimpleman, Larry, president, Retirement and Investor Services, Principal

Financial Group, Des Moines, IA, on behalf of the Business Roundtable ....... 26

Reuther, Alan, legislative director, United Auto Workers, Washington, DC ..... 28

Kroszner, Randall S., professor of economics, the University of Chicago Graduate School of Business, Chicago, IL .................................................................. 30

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

Opening statement ........................................................................................... 3

Belt, Hon. Bradley D.:

Testimony .......................................................................................................... 6

Prepared statement .......................................................................................... 37

Responses to questions from:

Senator Baucus .......................................................................................... 53

Senator Baucus on behalf of Senator Ken Salazar ................................. 53

Senator Hatch ............................................................................................ 55

Senator Rockefeller ................................................................................... 55

Senator Smith ............................................................................................ 58

Combs, Hon. Ann:

Testimony .......................................................................................................... 10

Prepared statement .......................................................................................... 60

Responses to questions from:

Senator Rockefeller ................................................................................... 66

Senator Smith ............................................................................................ 69

Grassley, Hon. Charles E.:

Opening statement ........................................................................................... 1

Prepared statement .......................................................................................... 71

Kroszner, Randall S.:

Testimony .......................................................................................................... 30

Prepared statement .......................................................................................... 72

Response to a question from Senator Baucus ................................................ 74

Reuther, Alan:

Testimony .......................................................................................................... 28

Prepared statement .......................................................................................... 75

Responses to questions from Senator Baucus ................................................ 82

Response to a question from Senator Hatch .................................................. 83

Page

IV

Rockefeller, Hon. John D., IV:

Prepared statement .......................................................................................... 83

Warshawsky, Hon. Mark J.:

Testimony .......................................................................................................... 8

Prepared statement .......................................................................................... 85

Responses to questions from:

Senator Baucus .......................................................................................... 100

Senator Bunning ....................................................................................... 100

Senator Hatch ............................................................................................ 102

Senator Rockefeller ................................................................................... 104

Senator Smith ............................................................................................ 106

Senator Snowe ........................................................................................... 108

Zimpleman, Larry:

Testimony .......................................................................................................... 26

Prepared statement .......................................................................................... 109

Responses to questions from:

Senator Baucus .......................................................................................... 126

Senator Hatch ............................................................................................ 126

COMMUNICATIONS

American Benefits Council ...................................................................................... 129

American Federation of Labor and Congress of Industrial Organizations ......... 162

American Society of Pension Professionals and Actuaries ................................... 164

The ERISA Industry Committee ............................................................................ 170

March of Dimes ........................................................................................................ 181

Society for Human Resource Management ............................................................ 183

(1)

FINANCIAL STATUS OF THE PENSION BENEFIT GUARANTY CORPORATION AND THE

ADMINISTRATION’S DEFINED BENEFIT

PLAN FUNDING PROPOSAL

TUESDAY, MARCH 1, 2005

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 2:20 p.m., in

room SD–215, Dirksen Senate Office Building, Hon. Charles E.

Grassley (chairman of the committee) presiding.

Also present: Senators Lott, Snowe, Crapo, Baucus, Rockefeller,

Bingaman, and Wyden.

OPENING STATEMENT OF HON. CHARLES E. GRASSLEY, A. U.S.

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. Today, our committee is going to hear testimony

on the state of the defined benefit pension plans. We will focus on

the government backer of that system, the Pension Benefit Guaranty Corporation, PBGC, for short. The administration’s recent proposal that they put before us to strengthen the pension funding

system will also be considered.

Defined benefit plans are, of course, a critical part of our Nation’s

pension system and they are very important to the economy as a

whole. These plans provide retirement income to millions of Americans. Millions of current workers count on these benefits as they

look forward to retirement.

Today, our defined benefit pension system is clouded with uncertainty. There is uncertainty for plan sponsors regarding the interest rate used to calculate our pension liabilities, and there is uncertainty for participants who read headlines and actually wonder if

their pension benefits will really be there when they retire.

In the last Congress, attention began to focus on replacing the

30-year Treasury rate for pension funding purposes with a new

rate. At the same time, questions began to be raised about whether

we needed to take a more comprehensive look at reforming the

pension funding rules.

Here in the Finance Committee, we worked in a bipartisan way,

which is the tradition of this committee, on a comprehensive bill

that has the acronym NESTEG. NESTEG included permanent replacement for the 30-year Treasury rate, with yield curves, along

with the first round of proposals from the administration, to

strengthen pension funding.

2

In acting on NESTEG, I, along with Senator Baucus, also asked

the administration to provide details on more comprehensive pension funding reforms on which they were working. We now have

those details, and we will spend a considerable amount of time

today discussing and debating them in this hearing. So, I look forward to a spirited and thought-provoking discussion.

I believe it is very critically important that we enact a permanent set of pension funding rules this year, with emphasis upon

permanent. It is critically important to our economy, it is critically

important to the companies that sponsor plans, and most of all it

is critically important for the workers who depend on these plans

for retirement.

To that end, I and Senator Baucus have reintroduced last year’s

committee-reported NESTEG bill and announced our intentions to

work to reform the pension funding rules in a permanent manner.

Defined benefit plans are a vital part of our private retirement

system. At the same time that we recognize the defined benefit

pension system’s many good attributes, it seems we must also be

mindful of its current problems. The PBGC’s current deficit is $23 billion. That is $23 billion of

exposure for all taxpayers. Most of those taxpayers do not have a

stake in the defined benefit system. Only about 20 percent of the

workers have a defined benefit plan, so about half of workers lack

an employer-provided retirement plan, either defined benefit or defined contribution.

So, they just do not have any of those benefits, and it seems to

me a very sad and disturbing statement in and of itself. Hopefully

we can move that percentage up quite a bit.

To the extent that progress has been made on increasing retirement plan coverage, this committee, I think, has been largely responsible. I worked to have retirement savings provisions included

in the 2001 tax bill, and I have enjoyed a long relationship working

with Senator Baucus on increasing coverage and improving our retirement system. One such idea is the bipartisan saver’s credit that

Senator Baucus pursued with others in the 2001 Tax Act.

Since only about 20 percent of the workers participate in a defined benefit plan, one question we have to confront is whether the

other 80 percent of the workers not covered by defined benefit

plans should be responsible for subsidizing the pension benefits of

the minority percentage that does have it.

There are other alarming trends to note as well. Many employers, particularly those in older industries, have over-promised and

under-funded, and sometimes both situations have existed of overpromising and under-funding. Those promises eventually become

due, and are coming due.

Too often, these businesses, with the collaboration of unions, act

as if their obligation to their workers are somehow not their responsibility, but the taxpayers’ responsibility.

Far too often, large companies have cavalierly sloughed off their

defined benefit liability onto the taxpayer. Far, far too often, the

taxpayers have ended up holding the bag on a badly negotiated employee benefit deal.

The administration, to its credit, has stepped up with a tough defined benefit reform package that would strengthen pension fundVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 23367.000 SFINANC2 PsN: SFINANC2
3

* For more information, see also, ‘‘Present Law and Background Relating to Employer-Sponsored Defined Benefit Pension Plans and the Pension Benefit Guaranty Corporation (PBGC),’’

Joint Committee on Taxation staff report, February 28, 2005 (JCX–03–05).

ing. The predictable howling from some employers and union

groups has already begun. I say to all those who are howlers something like Ross Perot would say: ‘‘I’m all ears.’’ I want to hear. But

what we do not want to hear, is complaints only.

Now, you can legitimately not like the administration’s tough

medicine, but, also, what is your solution? How do you assure the

taxpayers that we are not digging a bigger deficit ditch at the

PBGC? How do you assure current retirees that they can count on

funding sources for the benefits that were promised to them?

How do you assure workers that their promised defined benefits

will not be defined and paid for, not by your agreement, but by the

Federal Government, which is probably going to be a lot less? So,

I am looking for answers here. I am not looking for complaints

without constructive alternatives.

And while we are talking about constructive alternatives, I would

like to ask everybody who is in Congress to consider turning off

any anti-Social Security reform water cannons, for today, at least.

Let us put away the charts, shut down the biased benefit calculators, focus on solving the problem and doing the people’s business.

Instead of strident statements against any effort to reform Social

Security, I would like us to recognize that President Bush has

raised the profile of a Nation’s retirement security challenge.

If you laid out 10 charts in front of us, there would not be a Republican or Democrat who would disagree with the figures of what

the short funding and the liability is. It is also kind of a mathematical equation of what you put together to solve that problem.

So I think the President has used the bully pulpit to put retirement security issues front and center, and I do not think we should

waste the opportunity.

I am still hopeful that the Finance Committee can rise above the

discussions that really have not taken place yet between Senators,

but over the airwaves, and see what we can do about Social Security, because it is part of the three-legged stool of retirement that

Franklin Roosevelt talked about: pensions, personal savings, and

Social Security.

Of course, with what we are dealing with here today, fixing the

defined benefit system can be a part of that effort. I am not one

of those opposed to expanding the whole issue of Social Security beyond just Social Security to solving some of our retirement problems and encouraging more savings. We owe it to the people that

sent us here to focus on these problems. Most of us got on this committee to solve problems, and we are going to do that.*

Senator Baucus?

OPENING STATEMENT OF HON. MAX BAUCUS,

A U.S. SENATOR FROM MONTANA

Senator BAUCUS. Thank you very much, Mr. Chairman. I first

want to congratulate you on that colorful, metaphor-rich statement.

Second, I would say that I think all members of the Senate appreciate the President bringing to the fore some of the challenges facing Social Security.

4

Now, we all know it is not a crisis, but it is a long-term challenge. Medicare is much more of a crisis facing this country. That

trust fund is due to go belly-up very soon. Much more dire straits

face us because of the Medicare trust fund compared to Social Security.

Nevertheless, I appreciate the President raising the issue. I also

appreciate, frankly, the good judgment of the American people, our

employers, who have so far been fairly critical, quite critical, of the

President’s private accounts.

We all know that private accounts do nothing to solve the longterm solvency of Social Security, and actually increase the solvency

problems facing Social Security. So, as we work to try to find a solution, Mr. Chairman, I very much agree with you that we have to

look at all options. It is pension reform, it is personal savings, but

it is also not undermining Social Security, but strengthening Social

Security.

Mr. Chairman, I also might add that this hearing is quite important because we have to find good, long-term ways to strengthen

and fund a benefit pension system. It is one of the major cornerstones of retirement. I might remind us that the defined benefit

system provides retirement security for over 40 million Americans.

A lot of people depend upon defined benefit plans.

Of course, we are here to examine the financial status of the

Pension Benefit Guaranty Corporation, otherwise known as the

PBGC, and also the funding rules, that is, the amount companies

are required to contribute to their pension plans that underpin the

benefit promises to these millions of workers.

PBGC is feeling increasing financial pressure. I might remind us, at the end of 2004, PBGC had a deficit of $23.3 billion. That is a

$12 billion loss, in addition to—that is, over—the preceding year.

PBGC has estimated that single-employer plans covered by its insurance program are under-funded by a collective $450 billion.

That is a big increase from last year, when it was about $350 billion of under-funding. So, the trend is very much in the wrong direction.

These under-funded liabilities also come at a time when the

number of single-employer defined benefit plans covered by the

PBGC has declined precipitously, from a high of 112,000 plans in

1985, to fewer than 30,000 plans today.

As we examine pension funding, we must keep in mind that benefit guarantees and minimum funding rules must go hand in hand.

It is appropriate that we are addressing both of those here today.

In 1974, Congress passed something called ERISA. Not many

Americans know what ERISA stands for, but what ERISA basically

does is set some rules and guidelines. Someone once said, the only

person ever to really have understood ERISA and all the pension

law and all of its ramifications was the late Senator Jack Javitz,

one of the sponsors of ERISA back in 1974.

He was a great American. All of us who knew him had the highest regard for him. But Jake Javitz—Jack, to some of his closer

friends—was a great American who tried to help set us on the right

path to setting some guidelines for defined benefit plans.

Back then in 1974, PBGC was created, and also the minimum

funding rules for defined benefit plans were created. Before that

5

year, however, there were no guaranteed benefits. That is, if a pension plan terminated with insufficient assets, the participants—

that is, the employees and retirees—could lose everything.

When Congress established PBGC to provide participants—that

is, employees and retirees—with some level of benefit guarantee,

Congress also established minimum funding rules to make companies fund benefit promises in an orderly fashion.

Now, funding rules have always been challenging. Setting the

rules follows a difficult balance. If contribution requirements by

companies are set too low, workers risk losing promised benefits.

But if contributions are set too high, cash that could be used for

business expansion is tied up in the pension plan and companies

may not, therefore, offer the plans because of the cost.

To require this money to be contributed when a company is already struggling financially, you risk pushing that company over

the cliff into bankruptcy. So, there are no easy answers here. It is

a question of where you draw the line and the fairest place to draw

that line.

I want to thank the administration for its efforts. It has attempted to come up with a proposal. It has its own funding proposal, and I recognize the tremendous amount of effort that went

into it. It deserves very thoughtful consideration.

Some of our witnesses today, however, believe that the proposal

will hurt, not help, the defined benefit system. We will hear the

kinds of concerns that make defined benefit funding rules such a

challenge.

Some of their concerns are these. First, plan sponsors, they say,

need predictability of contribution requirements for cash flow planning, but the proposal before us may actually increase the volatility

of minimum funding requirements, clearly a point we have to look

at because we do not want a lot of volatility. On the other hand,

we want to make sure that these plans are adequately and properly funded.

Other concerns are that the proposal does not go far enough to

encourage employers to make contributions in excess of minimum

requirements, and linking a plan’s funding target to a company’s

financial health, the concern is, would result in a downward spiral

for troubled employers.

Clearly, we look forward to hearing from the witnesses. We very

much appreciate their expertise. It was just last spring that we

passed the Pension Funding Equity Act, and that provided a 2-year

temporary substitute of the interest rate on long-term corporate

bonds for the 30-year Treasury rate. That temporary substitute, we

all know, expires at the end of this year.

I hope that we can enact a long-term solution this year. There

have been too many times in this Congress, and particularly in the

last several years, where we just passed extensions: 6 months, 9

months, a year. We are falling into the trap here of too many extensions and not biting the bullet and settling down to try to pass

legislation that is more permanent.

Now, nothing is permanent, clearly, but the 2- and 3-year extensions, frankly, I think are a bad direction to be going in. Rather,

we need a little more certainty, a little more predictability to help

6

our companies, to help our employees, and frankly, help the country.

I hope we can enact that. I hope we can finally enact some kind

of a long-term solution here that includes not only the interest rate

replacement, but other reforms that are critical to the defined benefit system.

I look forward to our witnesses. Mr. Chairman, I thank you very

much for holding this hearing.

The CHAIRMAN. Yes. And thank you for your statement. I appreciate it very much.

We have at the table Mark Warshawsky, Assistant Secretary of

Treasury for Economic Policy; and Ann Combs, Assistant Secretary

of Labor for the Employee Benefits Security Administration. They

have lead roles at their Departments in developing the administration’s pension funding reform proposal. And we have Brad Belt,

who is the Executive Director of the PBGC.

So, unless you folks have worked out something different, I

would start with you, Mr. Warshawsky.

Mr. WARSHAWSKY. Actually, I think Brad will lead off.

The CHAIRMAN. Brad, you go ahead.

STATEMENT OF HON. BRADLEY D. BELT, EXECUTIVE DIRECTOR, PENSION BENEFIT GUARANTY CORPORATION, WASHINGTON, DC

Mr. BELT. Thank you, Mr. Chairman, Ranking Member Baucus,

and members of the committee. I commend you for your leadership

on retirement security issues, and I appreciate the opportunity to

discuss the need for comprehensive pension reform this afternoon.

My written testimony describes in detail the financial status of

the pension insurance program and the flaws in the current funding rules that have led us to this point.

I would like to mention just a few key points that highlight the

need for the administration’s reform proposals which my colleagues

will discuss momentarily.

The first point is that we have already dug a fairly deep hole and

it could get much deeper if we do nothing. PBGC’s accumulated

deficit, as the Chairman and Ranking Member noted, was just over

$23 billion at the end of this past fiscal year. That is a $30 billion

swing in just 3 years.

The most recent snapshot taken by the PBGC finds that corporate America’s pension promises are under-funded by more than

$450 billion. More important, almost $100 billion of this underfunding resides in pension plans at greater risk of termination because the sponsoring company faces financial difficulties.

I would note, Mr. Chairman, that the risks of further significant

losses are not limited to the steel and airline industries, as some

have asserted. Yes, the most immediate threat comes from the airline industry.

The PBGC recently absorbed the under-funded pensions of U.S.

Airways at a cost of $3 billion, and United Airlines wants to saddle

the insurance program with a claim of more than $6 billion.

Other airline executives have publicly stated that they would feel

competitive pressure to follow suit if United successfully transfers

its pension costs to the insurance program.

7

But the problem extends beyond airlines. As I noted, we estimate

that non-investment-grade companies sponsored pension plans with

a total funding shortfall of $96 billion. This exposure spans a range

of industries, from manufacturing, transportation and communications, to utilities, wholesale, and retail trade.

It would also be a mistake, in my view, to assume that these are

merely cyclical problems and that a return to the bull markets of

the 1990s will save the day. We cannot predict the future path of

either equity values or interest rates.

While equity markets have performed reasonably well in recent

months, long-term interest rates have stayed near historic lows.

More important, rising markets would not address the underlying

structural flaws in the pension system.

That leads to my second point, that the status quo rules have led

to this hearing. Simply put, the funding rules are needlessly complex and fail to ensure that pension plans are adequately funded.

Rather than encouraging strong funding and dampening volatility, the use of smoothing mechanisms and credit balances have

been primary contributors to systemic under-funding.

The sad fact is that companies can comply with all of the requirements of ERISA and the Internal Revenue Code and still end

up with plans that are much less than 50-percent funded when terminated.

The system is also rife with what economists call moral hazard.

A properly designed insurance system has mechanisms for encouraging responsible behavior and discouraging risky behavior. Unfortunately, the incentives in the pension insurance program run the

other way.

In addition, the system suffers from a disturbing lack of transparency. The current disclosure rules obfuscate economic reality,

shielding relevant information about the funded status of pension

plans from participants, investors, and even regulators.

The third, and most important point, Mr. Chairman, is that this

is not about the Pension Benefit Guaranty Corporation, it is about

the retirement security of tens of millions of American workers.

The fact is, the termination of under-funded pension plans can

have harsh consequences for workers and retirees.

The administration is committed to defined benefit plans, which

are an important source of secure retirement income. But when

plans terminate, workers’ and retirees’ expectations of a secure future may be shattered because, by law, not all benefits promised

under a plan are guaranteed.

Other companies that sponsor defined benefit plans also pay a

price through higher premiums when under-funded plans terminate. Not only will healthy companies be subsidizing weak companies with chronically under-funded pension plans, they may also

face the prospect of having to compete against a rival firm that has

shifted a significant portion of its labor cost onto the government.

In the worst case, PBGC’s deficit could grow so large that the

premium increase necessary to close the gap would cause responsible premium payers to exit the system. If this were to occur, Congress would face pressure to have U.S. taxpayers pay the benefits

of workers whose pension plans failed.

8

Mr. Chairman, the issues surrounding defined benefit plans ultimately boil down to one question: who will pay for the pension

promises that companies make their workers?

There are only four choices: the company that made the pension

promise, other companies through higher premiums, participants

through lower benefits, or taxpayers through a rescue of the insurance fund.

The administration believes that companies that make pension

promises should pay for their pension promises and not shift the

costs to others.

Thank you for inviting me to testify. Of course, I would be

pleased to answer any questions you may have.

The CHAIRMAN. Thank you, Mr. Belt.

[The prepared statement of Mr. Belt appears in the appendix.]

The CHAIRMAN. Mr. Warshawsky?

STATEMENT OF HON. MARK J. WARSHAWSKY, ASSISTANT SECRETARY FOR ECONOMIC POLICY, DEPARTMENT OF THE

TREASURY, WASHINGTON, DC

Mr. WARSHAWSKY. Thank you, Mr. Chairman.

Good afternoon, Chairman Grassley, Ranking Member Baucus,

and members of the committee. I appreciate the opportunity to discuss the administration’s proposal to reform and strengthen the

single-employer defined benefit pension system. In my testimony,

I will focus on the proposal’s funding rules, in particular, the calculation of the funding targets.

As my colleague, Brad Belt, described to the committee, the single-employer pension system is in serious financial trouble. Many

plans are badly under-funded, jeopardizing the pensions of millions

of Americans workers, and the insurance system which protects

those workers in the event that their own pension plans fail has

a substantial deficit.

The goal of the administration’s proposal is to enhance retirement security. The reforms are designed to ensure that plans have

sufficient funds to meet accurately and meaningfully measured accrued obligations to participants.

I believe that the current problems in the system are not transitory, nor can they be dismissed as simply the result of restructuring in a few industries. The cause of financial problems is the

regulatory structure of the defined benefit system itself. Minor tinkering with the existing rules will not solve these problems.

If you want to retain defined benefit plans as a viable option for

employers and employees, fundamental changes must be made to

the system to make it financially sound. The current rules are

needlessly complex, while failing to ensure that many pension

plans remain prudently funded.

The administration’s proposal addresses these problems and improves the funding rules. I will discuss the funding rules, while my

colleague, Ann Combs, will discuss the other elements of the proposal.

Accurate measurement is the predicate step in ensuring that

plans remain well-funded and workers’ and retirees’ benefits are

made secure. The system of smoothing embodied in current law

serves only to mask the true financial condition of pension plans

9

and to shift the risk of unfunded liabilities from firms that sponsor

under-funded plans to plan participants and other plan sponsors in

the pension insurance system.

Under our proposal, assets will be marked to market, and liabilities will be measured using a current spot yield curve that takes

account of the timing of future benefit payments summed across all

plan participants.

Discounting future benefit cash flows using the rates from a spot

yield curve is the most accurate way to measure a plan’s liability

because, by matching the maturity of the discount rate with the

timing of the obligation, it properly computes today’s cost of meeting that obligation.

Use of a yield curve is prudent and a common practice. Yield

curves are regularly used in valuing other financial instruments

and obligations, including mortgages, certificates of deposit, and

others.

The administration recognizes that the current funding rules,

particularly the deficit reduction contribution mechanism and the

limits on tax deductibility of contributions, have contributed to

funding volatility. This is a current problem.

Our proposal is designed to remedy these issues. We feel that increasing the contribution limit will give plan sponsors additional

ability to fund during good times.

Increasing the amortization period to 7 years compared to a period as short as 4 years under current law, together with the existing freedom that plans have to choose pension fund investments,

will enable plans to smooth contributions over the business cycle.

Plan sponsors may choose to limit volatility by choosing an asset

allocation strategy or conservative funding level so that financial

market changes will not result in large increases in minimum contributions.

These are appropriate methods for dealing with risk. It is inappropriate to limit contribution volatility by transferring the risk to

plan participants and the PBGC.

Under our proposal, planned funding targets for healthy plan

sponsors will be established at a level that reflects the full value

of benefits earned today under the assumption that plan participant behavior remains largely consistent with past history of an

ongoing concern. Plans sponsored by firms with below-investmentgrade credit will be required to fund to a higher standard that reflects the increased risk that these plans will terminate, and hence

that the take-up of early retirement benefits and lump sums will

be accelerated.

Pension plans sponsored by firms with poor credit ratings pose

the greatest risk of such defaults. It is only natural that pension

plans with sponsors that fall into this readily observable high-risk

category should have more stringent funding standards.

Credit ratings are used throughout the economy, and in many

government regulations to measure the risk that a firm will default

on its obligations. A prudent system of pension regulation and insurance would be lacking if it did not use this information.

Credit balances are created when a plan makes contributions

that are greater than the required minimum. Under current law,

10

a credit balance, plus an assumed rate of return, can be used to

offset future contributions.

We see two very significant problems with this system. First, the

assets that underlie credit balances may lose, rather than gain,

value. Second, and far more important, credit balances allow plans

that are seriously under-funded to take funding holidays. In our

view, every under-funded plan should make minimum annual contributions. Under our proposal, contributions in excess of the minimum will reduce future minimum contributions. These contributions are added to plan assets and, all other things being equal, reduce the amount of time that the sponsor must make minimum

contributions to the plan. We believe this is the correct approach.

In conclusion, we are committed to ensuring that defined benefit

plans remain a viable retirement option for those firms that wish

to offer them to their employees. The long-run viability of the system, however, depends on ensuring that it is financially sound.

Our proposal is designed to do exactly that, to safeguard the benefits that plan participants have earned and will earn in the future. We are committed to working with Congress to ensure that

the effective reforms that protect workers’ pensions are enacted

into law.

It has been my pleasure to discuss this proposal, and my colleagues and I look forward to answering any questions.

The CHAIRMAN. Thank you.

[The prepared statement of Mr. Warshawsky appears in the appendix.]

The CHAIRMAN. Now, Secretary Combs?

STATEMENT OF HON. ANN COMBS, ASSISTANT SECRETARY

FOR THE EMPLOYEE BENEFITS SECURITY ADMINISTRATION, DEPARTMENT OF LABOR, WASHINGTON, DC

Ms. COMBS. Thank you. Good afternoon, Chairman Grassley,

Ranking Member Baucus, and members of the committee. Thank

you for inviting us today to discuss the administration’s proposal

to strengthen the defined benefit pension plans.

The defined benefit system needs comprehensive reform. Mere

tinkering with the current rules will not fix its problems. The administration’s reform package will improve pension security for

workers and retirees, stabilize the defined benefit system, and

avoid the need for a taxpayer bail-out of the PBGC.

I am going to focus on three key elements of the proposal. First,

preventing hollow benefit promises by severely under-funded pension plans. Second, improving disclosure to workers, investors and

regulators. Third, reforming the PBGC premium system to better

reflect the real risks and the costs of the guaranty program.

Under the current funding rules, financially weak companies can

promise new benefits and make lump-sum payments that the plan

cannot afford. Workers, retirees, and their families who rely on

these empty promises can face serious financial hardship if the

pension plan is terminated. The administration’s proposal prevents

this by ensuring companies make promises they can afford and

keep the promises they make.

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First, the proposal would allow a plan to increase benefits only

if the plan is more than 80-percent funded or if the new benefits

are fully and immediately funded.

Second, a plan could not make lump-sum payments unless it is

more than 60-percent funded, or if the plan sponsor is financially

weak, more than 80-percent funded. This will ensure that workers

are treated fairly, preventing a run on the bank, where a few collect at the expense of those left behind in the plan.

Third, plans sponsored by financially weak companies that are

less than 60-percent funded would have no new benefit accruals

until their funded status improved. A plan sponsored by a bankrupt company would be frozen until the plan is fully funded.

Our proposal also prevents corporate executives from securing

their own retirements while workers’ plans are at risk, an abuse

recently seen in the airline industry.

Under our proposal, financially weak companies with severely

under-funded plans could not fund non-qualified deferred executive

compensation arrangements. Any money used for that purpose

would be considered assets of the pension plan and could be recovered by the plan.

Plans that become subject to any of these benefit limitations

would be required to notify affected workers, making them aware

that the deteriorating funding is threatening their benefits.

Our intent in proposing these new benefit restrictions for severely under-funded plans is two-fold. We want to create a strong

incentive for employers to adequately fund their plans, and we

want to be sure that the promises already made to workers are

honored before additional hollow promises are made, raising false

expectations that cannot be met.

The financial health of defined benefit plans must be transparent

and fully disclosed to workers and retirees, as well as to regulators

and investors. The administration’s proposal would accelerate and

improve annual disclosures to covered workers and retirees.

Each plan would disclose its funded status relative to its own

funding target for the current year and for the 2 preceding years,

along with information about the company’s financial health and

the PBGC guarantees.

These disclosures will ensure that workers have the information

they need to talk to their employers about the funding of their

plans and to make informed choices about their retirements.

It will correct the current situation where so many workers and

retirees have lost benefits with little or no advance warning, having been told that their plans were adequately funded.

Another key reform is to improve the timeliness and the accuracy

of annual plan reports to the government. Under current law, the

information reported does not accurately measure liabilities and assets and can be nearly 2 years out of date.

Under the administration’s proposal, each plan would report annually the market value of its assets and the value of its liabilities,

as measured on both an ongoing and an at-risk liability basis. The

proposal would also shorten the deadline for large, under-funded

plans to report their actuarial information.

In addition, under current law, certain under-funded plan sponsors must provide plan funding and related information to the

12

PBGC. Our proposal would allow such information to be disclosed

to the public, while protecting sensitive information such as trade

secrets.

Finally, our proposal will help restore the financial integrity of

the Federal insurance system by improving the PBGC premium

structure. It would immediately adjust the flat-rate per-participant

annual premium to $30 to reflect the growth in worker wages since

1991, when the current $19 figure was set. Going forward, the flatrate premium would be indexed for wage growth, similar to the

manner in which the PBGC guarantee limit is indexed.

All companies with under-funded plans would pay an additional

risk-based premium based on the plan’s funding shortfall. The

PBGC board would adjust the risk-based premium periodically so

that premium revenue is sufficient to meet expected claims and

pay off the current deficit over time.

The new risk-based premium will be far more reflective of actual

risk than the current-law variable-rate premium. Unlike the latter,

it will be based on an accurate funding target that takes account

of the plan sponsor’s financial condition.

To keep premiums to a reasonable level, we must relieve the insurance program of certain unreasonable risks. The administration’s proposal would freeze the PBGC guarantee limit when a company enters bankruptcy and help the PBGC collect missed required

pension contributions while the firm is in bankruptcy.

The proposal also would prospectively eliminate the guarantee of

shut-down benefits and prohibit such unfunded benefits in pension

plans. Shut-down benefits cannot be pre-funded because they are,

by definition, unpredictable events. They are more like severance

plans, and we believe they should be treated as such.

The Bush administration, in conclusion, is committed to working

with Congress to ensure that meaningful defined benefit pension

reforms like those included in the President’s budget are enacted

into law.

We look forward to working with the members of this committee

to achieve greater retirement security for the millions of American

workers, retirees, and their families who depend on defined benefit

plans.

Thank you very much. I, too, would be happy to take questions.

[The prepared statement of Ms. Combs appears in the appendix.]

The CHAIRMAN. I thank the entire panel. We will have 5-minute

turns.

My first question is directed towards anybody on the panel who

would want to answer. I think all three of you can answer it, but

maybe if it is the same answer, just have one answer.

It is my understanding that United Airlines’ pension plans might

be $8 billion under-funded, and if United succeeds in dumping

these liabilities, that the PBGC will have to absorb a $6 billion hit.

But I have also been told that United’s pensions have been funded

consistently with the rules.

So, I need to have you explain to me what the problems are with

the current rules that will allow a situation like this to occur, and,

if there are external factors outside the rules, could you comment

on other factors at work here?

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Mr. BELT. Mr. Chairman, I would be delighted to take first crack

at that one. United does present an interesting case example of the

problems that exist under the current funding rules. It was really

a combination of factors that got them to the point of being $8 billion under-funded.

Going back a little bit in time where they were already substantially under-funded, about the 2000 time frame, at least on a termination liability basis, even though they were reporting to investors

and shareholders that they were fully funded, they stopped making

contributions into the pension plan because they were taking advantage of credit balances, notwithstanding the fact that asset values were falling and liabilities were continuing to accrue, and liabilities were also going up because interest rates were falling.

Notwithstanding the fact that they were putting no money into

the plan and the plan was becoming increasingly under-funded,

also during this time they were able to negotiate new benefit increases. As a result, over a period of about 3 or 4 years, the total

amount of under-funding grew by $3 or $4 billion, fully consistent

with the rules.

As a result, if the plan does terminate—and that is what the

company has indicated its intention is—their total under-funding is

about $8 billion, and the Pension Insurance program would assume

a liability or a claim of more than $6 billion. Again, and they make

this point in their court papers, they have fully complied with the

ERISA funding rules.

The CHAIRMAN. Some groups seem to believe that the PBGC

might be crying wolf. They believe that much of the problem is either cyclical due to the ‘‘perfect storm’’ of low interest rates and low

stock market values, or the result of industry-specific problems,

steel and airlines as an example. How do you view the causes of

the current situation? Will cyclical changes over time remedy the

problem in industries other than airlines and steel?

Mr. BELT. As I noted in my testimony, Mr. Chairman, the risks

faced by the Pension Insurance program and the significant levels

of under-funding, particularly that $100 billion that I mentioned

that is in plans sponsored by companies that are not as financially

healthy, is in a wide variety of different industry sectors. In fact,

a majority of that is outside of airlines and steel. So, there are significant risks beyond just those two industries.

It is distinctly possible that we could see a return to the bull

markets of the 1990s. It is distinctly possible that we could have

a sudden spike in interest rates that would close this funding gap.

It is also just as possible you could go the other direction. Longterm rates in other countries are much lower than they are in the

United States right now. We could certainly see markets fall at

some point in time.

So, we’ve got a significant hole right now. Unfortunately, it’s

growing bigger rather than filling the hole. I think the most important point to note is that the current system has allowed us to get

to this very deep hole and allows the hole to continue to get deeper.

The CHAIRMAN. My next question would be for anybody on the

panel. We are going to hear, during the second panel, testimony

from business and labor groups criticizing the yield curve as creating too much volatility in pension funding, primarily because of

14

the use of the near-spot interest rates and the elimination of

smoothing mechanisms that exist under current rules.

They also criticize the use of credit ratings for various purposes

under the proposals. So I need to have, from one or all of you, a

response to those criticisms we are going to hear in the next panel.

Mr. WARSHAWSKY. Mr. Chairman, I will take that question.

Number one, we feel it is very important that assets and liabilities

are measured accurately. The smoothing which is currently used

may, in fact, be masking the true status of the plan.

We also feel that the new tools that we are proposing—the 7-year

amortization and the ability to make additional tax-deductible contributions—will enable companies to manage the volatility in an

appropriate and prudent way. With regard to credit rating, we also

feel that this is a very important reform, basically reflecting the

risk that those plans represent.

The CHAIRMAN. All right.

I am very concerned that any pension funding reforms give employers ample ability to advance-fund their plans during good

times. In that regard, I am pleased to see that your proposal included a significant increase in the ceiling on employer contributions identical to what this committee has done in the NESTEG

bill.

Now, some have argued—and I think some of these folks will be

represented on our second panel—that your proposals limit the incentives to advance-funding by eliminating credit balances.

Do you believe that it is necessary to eliminate credit balances

altogether rather than reform them to make the proposal work? I

want to remind the committee, I started my question before the red

light went on. [Laughter.] Go ahead and answer, please.

Mr. WARSHAWSKY. Mr. Chairman, we feel that the generous allowance of additional funding will be very helpful in allowing plans

to manage the risks that they undertake.

We also feel that the current system, as Brad Belt has indicated,

has really been rife with abuse because the credit balances do not

reflect market value of assets, but even more importantly, they

allow companies to take very extensive funding holidays, sometimes a matter of years, when the plan is under-funded. That is

simply inappropriate.

Mr. BELT. And, Mr. Chairman, if I could add to that, just a specific example, citing back to United. This is from information that

United provided in the bankruptcy court proceedings. This is not

PBGC’s information.

They noted that they used credit balances for their pilots’ plan

from the period of 2000, running all the way through the end of

this year, in which they had put no money into the pilots’ plan because of the credit balances that were available to them, notwithstanding the fact that when we take over that plan it is going to

be $3 billion under-funded. So, for 5 years they have been able to

use credit balances to not put any money in the plan, notwithstanding the fact that liabilities have grown substantially.

The CHAIRMAN. Thank you.

Now I am going to call on Senator Baucus. But it would be this

order: Senator Crapo, if he would return; Senator Bingaman, if he

15

would return; then Senator Wyden, Senator Lott, Senator Rockefeller, and Senator Snowe, in that order.

Senator BAUCUS. Thank you, Mr. Chairman.

I have four questions, and I do not really care who answers

them. You can decide among yourselves. But I am going to ask

each of the four, and then ask you to answer all of the four. The first, is the proposal shows that $26 billion is to be raised

by premiums over the next 10 years. In view of current premium

revenues, about $1.5 billion per year, that calculates to about a

170-percent increase in premiums.

My first question is, how much of that is due to the flat-rate premium and how much to the variable, and what problems might

that cause employers?

The second question is, we were here 10 years ago dealing with

all this, and we thought we had it all solved and the system was

flush for a while. Now, here we are again. So my question is, how

can we be assured that we will not be back here 10 years later with

these same problems, based upon your suggestions?

The third question is, many negotiated plans have flat-dollar

benefit formulas, while most plans for management and other nonunion employees have a formula tied to salary, so there is built-in

inflation for salaries of employees, but not for wage earners. Under

a flat-dollar plan, it takes a plan amendment to adjust benefits for

inflation.

I would like for you to explain how your proposal’s limitation on

benefit increases for plans that are less than 80-percent funded affects those two different types of plans.

Then, finally, I am just curious. The administration thinks that

individuals with Social Security should invest in equities. Why is

the same not true for retirees and employees where, in this case,

professional investment advisors have managed defined benefit

plans that would not allow investment in equities, but rather there

is a very strong, implicit position that the plan should be invested

in a bond portfolio?

So if we do not trust plans with financial advisors to invest in

equities and plans, why in the world should we be trusting individuals to invest in equities for their defined benefit portion that is

the nature of Social Security? Those are the questions.

Mr. BELT. I guess I would be happy to take the first one, Senator

Baucus, on the premium issue.

Under current law, we have historically derived about a billion

dollars a year in premium revenues, but that has been trending up

a little bit. It was about $1.5 billion this year, and it is estimated

in our baseline assumptions to be a little over $2 billion going forward. Of the $26 billion that you have mentioned, that is for budget estimate purposes.

The proposal is actually to increase the flat-rate premium from

$19 per capita to $30 per capita, and that would be the first increase since 1994 in the flat-rate premium, which would bring the

flat-rate premium revenues to close to $1 billion a year. They have

been about $600 million a year to about $1 billion, and that is compared to claims of $16 billion just over the last 3 years.

Senator BAUCUS. Well, just so we get our facts straight, is that

a 170-percent increase?

16

Mr. BELT. No, it is not, not over baseline assumptions. It is about

a 50-percent increase in the flat-rate premium. The variable-rate

premium, the policy proposes that the PBGC board would set that

based upon current facts and circumstances.

So, there is no established variable-rate premium. What is established in the proposal is that the flat-rate premium would increase

from $19 to $30.

Senator BAUCUS. All right.

Next question?

Ms. COMBS. We have negotiated here. I think I will take the second one, which was how can we ensure that we are not back here

in 10 years.

Senator BAUCUS. Yes. Right. What is there about this proposal

that reasonably assures we are not going to be back here again?

Ms. COMBS. Well, I was actually involved 10 years ago as well,

so we all have incentives to get it right this time. I think we have

added some additional and different elements in this proposal

which will give us better assurance that we can solve the problem

going forward. I think, importantly, we have introduced for the

first time the idea of the financial risk of the plan sponsor.

I think our experience has shown at PBGC that it is not just the

funding rules—they are very important because they determine the

size of the claim—but it is the financial health of the company

sponsoring the plan that determines the incidence of the claim,

whether or not the plan will be terminated.

So, I think our proposal to have both the funding targets and the

premiums linked to the financial riskiness of the firm is an important change, and one that will help a great deal.

I also think our willingness to take on the issue of benefit limitations, which we recognize is a sensitive issue but one that we think

is very important, if you are in a big hole and you have not paid

for the promises you have already made, we think the law should

restrict your ability to keep making additional promises.

Senator BAUCUS. If I might, just very briefly. I find it hard to

think we should give a big extra hit to companies that are stressed.

Why stress them more if they are already stressed?

Second, some of the stress is going to be through no fault of their

own. A very well-managed company, whether it is a big change in

trade law, or who knows what, a flood, or something might happen

that puts a company in a very financially stressed position.

Ms. COMBS. Well, our proposal does not create any new exposure

for companies. These promises have been made, these liabilities are

there. What we are trying to do is have more transparency about

what the liabilities actually are and a reasonable period of time for

people to meet those obligations, and, again, some real incentives

for them not to continue to make promises that they cannot fund.

So we are hoping that companies can get themselves, over a reasonable period of time, into a situation where the true liabilities

are recognized and funded and that plans do not get in a situation

where they continue to allow these plans—it is the unfunded liability that creates the problems, the financial problems, for these companies now, not the other way around.

Senator BAUCUS. Right.

17

Ms. COMBS. And their financial situation should not be financed

on the pension plan.

Senator BAUCUS. I do not want to take advantage of my colleagues, but if someone could very briefly, just maybe in one sentence, address the other two.

Mr. WARSHAWSKY. Well, let me address your final question on

equity investments. The proposal does not direct companies to invest plan assets in bonds.

Senator BAUCUS. That is the implied assumption.

Mr. WARSHAWSKY. Not necessarily. It depends on the company’s

situation. It depends on the demographics of the plan. It depends

on the tolerance of risk of the company. It is really their choice. We

are providing tools to manage risk, but we are not directing them

to invest in any direction one way or the other.

Mr. BELT. And I would also note that, in contrast to the Social

Security situation, the participants’ benefits are derived by formula. They do not directly benefit from any increases realized by

the pension plan. Those may or may not inure to the benefit of

shareholders, but they do not inure directly to the benefit of the

participants.

Senator BAUCUS. And, very briefly, the difference between salaried employees and non-salaried employees?

Ms. COMBS. On the benefit limitations, the hourly plans, you are

correct. When they negotiate a benefit increase, there is a past

service liability that springs up, if you will, and we would have

that amortized over the full 7-year period. So, that would be reflected. In salary plans, they are automatically kind of adjusted because it is in the salary function.

Senator BAUCUS. Is that fair?

Ms. COMBS. We think we create more parity between the two.

Also, for the first time, we would allow hourly plans to anticipate

future salary in the maximum contributions that they can make.

Senator BAUCUS. All right. My time has expired. Thank you.

The CHAIRMAN. Thank you, Senator Baucus.

Now, Senator Bingaman?

Senator BINGAMAN. Thank you very much, Mr. Chairman.

Thank you all for testifying. I understand some of your proposals,

and some of them sound meritorious to me. I saw an editorial in

Business Week, January 31, that caught my eye. ‘‘Do Not Pass the

Buck on Pensions,’’ was the name of it.

It said, ‘‘The PBGC insures the pensions of 35 million Americans,

but lately it has been insuring the financial success of turn-around

specialists who buy weak companies with big legacy costs, dump

their pensions on the PBGC, and flip the assets for hefty profits.’’

Then it goes on to say, ‘‘When the government bailed out Chrysler Corporation 2 decades ago, it demanded an equity kicker for the

loans. When it offered loan guarantees to the airlines after September 11, it made equity part of the deal. If the PBGC is to play

a central role in making the U.S. economy more efficient, it should

demand no less: equity is the answer.’’

What is your reaction to that? Since we are talking about this

law, why do we not provide that if you have to come in and take

over these pension obligations of a company, that if that company

18

re-emerges as a profitable entity, you wind up owning a chunk of

it? Would that not help solve your financial problems?

Mr. BELT. Senator Bingaman, actually, under current law, in

some cases, our recovery will turn out to be equity. There may not

always be cash available in the company once it emerges to be able

to satisfy the claims owed to the Pension Insurance Fund. It is distinctly possible, for example, in the United Airlines case, that our

recovery could be in the form of equity. We could become a substantial holder in United Airlines.

The situation you were alluding to is a different one. It is not

when the company re-emerges or re-organizes under bankruptcy,

but actually liquidates their assets and you find somebody coming

along and picking up the leftovers and then pumping new money

in, and now that the pension liabilities have been shed, being able

to make a go of the business.

That is a function of the current law that does not address asset

sales or liquidations. But in the case of reorganization, in some

cases the PBGC will end up with equity.

Senator BINGAMAN. But do you agree with the thrust of the editorial, that we ought to change the law so that when the pension

obligations are shed, PBGC winds up with equity?

Mr. BELT. Our focus in the administration has been on making

sure that pension plans are well-funded. Hopefully, they do not terminate at all, and then if they do terminate, they are fully funded

so these are not issues. So, that is where we want to really put the

attention.

At the margins, there are other situations that may arise. For example, part of the administration’s proposal is to strengthen

PBGC’s claim in bankruptcy in a limited context, but even there,

there are trade-offs.

Our focus has really been making sure that hopefully pension

plans do not terminate in the first place, and when they do, there

are assets there to satisfy the liability so this does not even become

an issue.

Senator BINGAMAN. Well, but your focus is also to try to ensure

the long-term solvency of PBGC. This is a suggestion they are making for how that could be accomplished, but you have no position

on whether this makes sense as a partial way to ensure PBGC’s

long-term solvency?

Mr. BELT. I have got to be honest, Senator, I have not thought

through fully the ramifications on the asset sale side. As I indicated already, in reorganizations, there are cases where part of our

recovery is equity.

We will try to do whatever we can to maximize the value to the

Pension Insurance program, and that is usually taking hard cash,

if we can get it. We would prefer not to take paper if we could

avoid it.

Senator BINGAMAN. If you have any more thoughts on that as

this is considered, I would be anxious to see them.

One other aspect of your proposal that I had some concern about.

As I understand it, you have a new provision in here to limit the

ability of corporations to have preferential funding for executive

compensation, but just in certain circumstances.

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There are many other circumstances where you are limiting the

ability of a company to increase benefits for employees, but doing

nothing to restrict the ability of the company to provide preferential funding for executive compensation.

Why is what is good for the goose not good for the gander? If we

are going to limit the ability of regular employees to get increased

benefits, why should we not have the same limitations on executive

compensation in all circumstances?

Ms. COMBS. We agree with your premise, and we are motivated

by the ‘‘what is good for the goose is good for the gander’’ situation.

We also recognize that, in most circumstances, now, the top executives in a company are not receiving most of their retirement income from the qualified pension plan, it is coming through executive compensation.

So, we analogized the prohibition against preferential funding to

the freezing of the plan. It is a pretty draconian event. Companies

do not generally move to set aside funding for this non-qualified executive compensation until they are facing bankruptcy or until they

think they might actually be at risk.

So, we were targeting it towards that circumstance where we

found that there was a real risk of a plan going into bankruptcy.

We wanted, at that point, to freeze the plan and not allow them

to fund executive compensation.

They do not really take that step, in our experience, to secure the

non-qualified executive compensation until they are faced with that

kind of a situation, so it was not a real threat. That was our

thought process in what we chose to do, but we are happy to discuss this issue with you as we go forward.

The CHAIRMAN. Thank you, Senator Bingaman.

Now, Senator Wyden, then Lott, Rockefeller, and Snowe.

Senator WYDEN. I want to ask about this question of forwardfunding as well. Let me start with you, if I might, Mr. Belt.

It seems to me that, as much as anything, what we ought to be

doing is going back to the old-fashioned principle of saving for a

rainy day. That is not what we have done, for years, with pension

law.

Now, last year’s committee bill and the administration’s proposal

both suggest allowing companies to contribute more during good

economic times. But my sense is, that is not going far enough. Just

allowing it, I think, means that we are not going to get a whole

lot of that new economic thinking into our system any time soon.

Would it not make sense for our committee to look and to work

with you all on specific incentives to get those kinds of savings-fora-rainy-day programs in place?

Mr. BELT. Senator, we believe there are outstanding incentives

in place in the administration’s reform proposal to actually fund

up. Not only do we have a required 7-year period over which to amortize under-funding, the increase in the maximum guarantee

limit, maximum contribution limit, provides, I think, powerful incentives for companies to be able to pre-fund those obligations.

Number one, they shorten the amortization period. If they put

money above the minimums, they shorten that 7 years by 1, 2, or

3 years, or they can totally pre-fund the obligation. Two, they get

a tax-deductible contribution for those dollars.

20

Senator WYDEN. How much is that tax deduction?

Mr. BELT. They can take it up to 130 percent of their funding

target and always can fund fully to at-risk liability. So, that is a

substantial increase over current law, but I would defer to my colleague, Mr. Warshawsky.

Mr. WARSHAWSKY. If I understand your question, basically the

way we have——

Senator WYDEN. My question, as I read the proposal, is you all

allow people to make these forward contributions, but those really

are not the kind of incentives that I think are going to send a big

message out there; that is just garden-variety common sense.

Mr. WARSHAWSKY. Well, they would get a dollar-for-dollar reduction in the amount of the variable rate of risk-based premium, so

if they are going to complain about premiums being too high, they

can directly reduce the amount of premiums they would pay. So,

we think that creates a very powerful incentive to go ahead and

put money in now.

They could also improve their credit rating in the capital markets. They could enhance their ability to offer new benefits to employees. There are a whole host of incentives built into the administration’s proposal.

Ms. COMBS. We are also moving the target up. Under current

law, they have funded 90 percent of what is called current liability.

We are having a tougher target, having them get to 100 percent.

So, there is some of that, too.

Senator WYDEN. I will follow up with them on that.

Ms. COMBS. We would be happy to work with you on these

issues.

Senator WYDEN. Let me ask you another one. Part of your mission is to try to promote defined benefits. As I look at this proposal

and the debate that has surrounded it, it is like you all assume

that the defined benefit is going to be a dinosaur. You are writing

it off as an artifact of history.

I think we all understand that times have changed, but I am not

one who is just going to write them all off. What are you prepared

to do as part of this newly defined mission to promote something

that I, and I think a lot of Americans, think is important, and that

is to do everything possible to promote defined benefits?

Mr. WARSHAWSKY. Senator, I believe that our proposal actually

has not written off the defined benefit system. Quite the contrary.

But one has to recognize that in order to encourage the formation

of new plans—and these might be plans offered by small companies, but small companies eventually become large companies and

increase their employee base—we have to simplify the system.

We have a remarkably complex set of rules, and we feel as if we

have achieved a lot of simplicity and rationalization of the rules,

which will be particularly beneficial for small plan sponsors.

The other thing we have to recognize is that there is an overhang. The PBGC deficit and the exposure that the PBGC has, really have to be dealt with in order to invite new plan sponsors to

come into the system.

Senator WYDEN. So your theory is that you have a plan that will

deal with the PBGC deficits in the short term, and as a result of

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that, defined benefits are not going to be dinosaurs headed for extinction?

Mr. WARSHAWSKY. Well, I would say that the idea is to work off

the PBGC deficit in a prudent and timely manner.

Senator WYDEN. I will tell you, and I intend to work with you

on the questions I am talking about, I also happen to think that

Senator Bingaman is raising an important point because it sure

looks to us like a lot of these turn-around specialists are getting

a sweetheart deal.

They come on in there, take somebody with really nothing but

assets, send you the pension costs, and walk away with the profits.

So, I am going to be interested in exploring that and these other

two matters with you.

I am particularly concerned about that second question I asked,

because as I look philosophically at where we are headed, I am not

prepared to say—and we may not have as many defined benefit

plans as in the past—as a formal policy statement, just not going

to say defined benefits are a dinosaur.

I really think that that underlies much of the administration’s

thinking, and I am troubled by it. You all are shaking your heads,

and we can debate it as we go forward in this discussion. Thank

you, Mr. Chairman.

The CHAIRMAN. Senator Lott?

Senator LOTT. Thank you, Mr. Chairman.

Ms. Combs, let me begin with you. You identified three things

that your proposal, the administration’s proposal, would attempt to

do. One of them is benefits limitations. Briefly touch on the other

two. There was the other one with regard to the executive benefits

package.

Ms. COMBS. That is part of the benefit limitations, Senator.

Senator LOTT. All right.

Ms. COMBS. The others were disclosure, better transparency and

more disclosure to workers and investors and regulators. The third

was the premium proposal, to increase the flat-rate premium from

$19 to $30 and change the risk-based premium.

Senator LOTT. Mr. Warshawsky, is it true that, under the current situation, when you are doing well you actually pay less, and

when you are doing poorly you have to pay more? There is an inversion there that guarantees failure when you get into the tank,

so to speak. When you start sliding down, you have to pay more

and it keeps forcing you down toward bankruptcy. Right?

Mr. WARSHAWSKY. Under current law, Senator, that is largely

correct.

Senator LOTT. Does the administration’s proposal do anything

about that?

Mr. WARSHAWSKY. We believe it does. Number one, we remove

the mechanism of the deficit reduction contribution which causes

that problem. Number two, we have expanded the amortization period to 7 years. Number three, a lot of times that problem is caused

in sort of a perverse way by the masking of the true status of the

plan.

The plan sponsor is lulled into thinking—and perhaps others are

lulled into thinking—that the plan is well-funded, when in fact it

22

is not. When the smoothing mechanism expires, then, lo and behold, all of a sudden it has to make massive contributions.

So, we feel that it is very important to have an accurate depiction of the plan’s financial status and then to allow plan sponsors

to manage that appropriately.

Senator LOTT. I think we ought to look at that very closely. I

want to make sure that you have done enough there to deal with

that problem.

I do, particularly, like the idea of the benefits limitations because

I do think that has driven a lot of the companies into the situation

they are in. I mean, they made commitments on benefits that they

should never have committed to and cannot afford, cannot pay. It

is driving them into bankruptcy. But the fact of the matter is, they

are there.

Particularly, Mr. Belt, with regard to, I guess, some steel companies, but airlines, it looks to me like you have not taken cognizance

of their situation and the fact that there are two airlines already

in bankruptcy, and one, two, three, four others could be in the

same situation. It almost looks like you want to put them into

bankruptcy and force them to terminate their plans. That could not

be a healthy situation for PBGC, correct?

Mr. BELT. Very much to the contrary, Senator. We have been obviously fighting U.S. Airways and United Airlines in bankruptcy,

indicating, particularly in the case of United Airlines, we do not believe they necessarily meet the distressed termination criteria that

are established in law. There is no question that the airlines represent a huge chunk of exposure for the Pension Insurance program, about $31 billion at the end of last year.

The last thing we want to do is have to take over those liabilities. It would be much more preferable if those companies were

able to maintain their pension plans, honor the promises they have

made to their workers and retirees, and do that and stay out of

bankruptcy and stay away from the Pension Insurance program.

Senator LOTT. But I do not think that is what you do here. It

looks to me like you really have not taken cognizance of their situation. They want to pay their benefits, but I presume they want to

freeze them and pay back what they owe over a period of time.

Seven years is probably not enough to deal with that.

Mr. BELT. Well, the problem is, current law right now requires

them, particularly if they fall under the DRC, the deficit reduction

contribution rules, to pay off those obligations sometimes in much

less than 7 years. That is under current law.

Senator LOTT. And we know that that is not adequate and is a

real problem, and we want to change that.

Mr. BELT. The administration’s proposal says we will actually

give you 7 years to pay off those obligations. But we are also trying

to address the problems, as I noted at the outset with respect to

United and others—and United is only illustrative—of what led

them to get to the point where, for example, in United’s case, they

are $8 billion under-funded when they were not putting any dollars

into the pension plan, even when they were fairly healthy and negotiating new benefit increases when they were substantially

under-funded.

23

Senator LOTT. But when did PBGC know that they were not paying what they were supposed to be? It seems to me that is when

you should have acted. Somebody should have stepped in and said,

you have got to be paying your obligations here.

Ms. COMBS. The law allows it.

Mr. WARSHAWSKY. The law allows it.

Senator LOTT. It allows them to stop paying because they have

the credits built up.

Ms. COMBS. The credit balance.

Mr. WARSHAWSKY. Yes.

Senator LOTT. Which guarantees that they will be in the situation they are in now. I am being told that what you are proposing

is not going to help the airlines. They want to pay the benefits they

say they owe, but they want to freeze the plans immediately and

then have a period of time longer than 7 years to get back into the

position they need to be with regard to what they owe.

Mr. BELT. Well, I certainly appreciate the difficult challenges

that some of the airlines are facing, but they have the complete authority under current law to freeze their plans.

That is governed by the collective bargaining agreement. So if

they can negotiate with their unions, and the pilots have expressed

some willingness to do that, they can freeze their plans under current law.

They would have, under the President’s proposal, 7 years to

make up that deficit. Also, we’re not changing the process for obtaining waivers in instances of temporary business hardship, if

that is what the case is, to extend that out a little bit further.

In those cases, you sit down with the Internal Revenue Service

and the PBGC to negotiate the terms of those waivers.

Senator LOTT. Since I see the red light, I will just conclude here.

For 2 years, I chaired the Aviation Subcommittee, a Commerce

Committee. I follow what is happening there. I really want our airline industry to be able to return to profitability. They have got lots

of problems, from fuel, to government fees for security. But this is

a huge problem, too.

If we do not address this in a way that people get the benefits

they are entitled to, but also make sure we have set up a glide

path for them to be able to gain altitude, we are going to have a

lot more debt dumped on PBGC. So, I do not think the administration has done enough in this area.

I am not sure I am expert enough yet to know what to do, but

I think we should address the pension plans, and more attention

to the airline industries is going to have to be included as part of

that. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator Lott.

Now, Senator Rockefeller?

Senator ROCKEFELLER. Thank you, Mr. Chairman.

Mr. Chairman, Senator Lott was on the point that I wanted to

get at too, but he expressed it extremely well. So I guess what I

can best do, is say that I think there are some very good things

that Senator Bingaman said about this, about the plan here.

But airlines are different. International commerce shuts down, at

least within a fairly transnational area. It just flat-out shuts down.

What it does to the markets is far greater than what happens if

24

some other kind of industry goes into bankruptcy and has to depend upon the PBGC. It is unique. It is psychological.

I would say to you, Mr. Belt, you talk about, they negotiate their

way out with their unions to get sacrifices. That has been, actually,

quite extraordinary, it seems to me, the amount of give-back and

savings on both sides that have been allowed to happen.

But I would say that Senator Lott and I—we have not discussed

this directly—are both very, very worried that we could have a system here where you have got a sudden thing, like something gets

caught up in a vortex, and if one industry, a particular type, an

airline industry, a particularly sordid bankruptcy happens—which

of course has happened—but it has been able to have been absorbed, but there comes a point where you cannot absorb anymore.

Let me make the opposite point. In the railroad business, when

I came here 20 years ago, there were 50 Class A railroads. There

are now four, and about to be two. In that case, that is tremendous

efficiency. Now, I might have some other problems with that, but

the airline case is the other.

They cannot go down to one or two airlines. There has to be the

alternatives. They have to divide up the country in various ways.

There has to be a hub-and-spoke system. I am genuinely worried

about what happens to them if they get caught in this vortex of

downward spiral. I just would say that because I think that Senator Lott asked my question very, very well.

The other thing is highly speculative, but it is of interest to me.

Senator Baucus was indicating we were here 10 years ago worrying

about the PBGC, but it was only, what, 5 years ago that the PBGC

had about a $9.7 billion debt, and it is now over $23 billion.

You have a lot of industries within the group, which are now trying to make it, which are funded by junk bonds. If you had a situation wherein a great quantity of those folded, you could—and this

is just calculation from within my office—get yourself up to a $90

billion deficit very, very quickly.

I do not know what you do at that point. The reason I am asking

is, you are not borrowing money at this point. If you got into those

kinds of numbers, let us say we hit a really rough patch. And it

has been dicey over the past 30 years, really going back to the late

1970s and early 1980s, and on. The economy has been very much

up and very much down, but we have not really had the consequences because we have not been trying to do as much as we

are trying to do now, and therefore having less Federal support.

At what point do you see the PBGC, if you see it at all, having

to go outside to borrow money? If that were to be the case, from

whom might it be? A very esoteric question, but it interests me.

Mr. BELT. Senator, you have raised a host of issues, and we try

to address that. I mean, one thing to note is that, by law, under

ERISA, we are supposed to be self-financing. We have no claim

upon the American taxpayer and our only source of revenues is

premium revenues, as well as returns on assets that we take over.

I think that is the key point.

Many of the folks who argue for the status quo suggest that nothing needs to be done. This $23 billion deficit is somehow a chimera, that we can wait until tomorrow to put this off, because the

fact is, whenever we take over a terminated plan, we take over the

25

assets of that plan. That allows us to write checks to people who

are getting benefits at that point in time.

The problem is, in each and every instance when we take over

a terminated plan there are a lot more liabilities there than the assets we take over, but those are paid off over a long period of time.

So, theoretically we could continue to grow in all the wrong ways,

continue to take on a lot more assets in these plans that are terminated. We still have the ability to write checks for a period of time,

but the hole gets bigger, and bigger, and bigger, and bigger. Somebody has to pay that at some point in time.

The fundamental question is: who pays that? We are trying to

make sure that the hole does not get any bigger, and that is what

the administration’s proposal is all about.

In a very measured way, we begin to fill that hole, so we never have to get to that day of reckoning where we have that $50, $90,

or $100 billion-plus deficit that some have suggested could come by

doing nothing.

Mr. WARSHAWSKY. Senator, I would also add that, given the

stage that we are in in the economic cycle, we have recovered, and

corporate profits are at an all-time high as a percent of GDP. So,

actually the timing is very good. This is a good time to fund the

plans, and companies have excess cash. Many companies have, in

fact, put money in their plans; General Motors made a very substantial contribution. We really would like to see that be the solution.

Senator ROCKEFELLER. All right. My time is up. Thank you.

Senator LOTT. Thank you very much, panel, for your participation today. I am sure we will be talking a lot more about this in

the weeks and months ahead.

Now, at this time I would like to introduce our second panel of

witnesses as this panel leaves and the new panel comes forward.

I would just introduce them, briefly.

First, we welcome Larry Zimpleman, testifying on behalf of the

Business Roundtable and a broader umbrella of business groups,

including the American Benefits Council, the American Council of

Life Insurers, the ERISA Industry Committee, Financial Executives International, the National Association of Manufacturers and

the U.S. Chamber of Commerce. An impressive list.

Larry is president of the Retirement and Investor Services at the

Principal Financial Group in Des Moines, Iowa. I suspect that last

point explains why Chairman Grassley would want Mr. Zimpleman

to be here.

We will then hear testimony from Alan Reuther, who is the Legislative Director for the International Union of United Automobile,

Aerospace, and Agriculture Implement Workers of America, commonly known as UAW.

Last, we will hear testimony from Randall S. Kroszner, Professor

of Economics at the University of Chicago Graduate School of Business.

Thank you all, gentlemen, for being here. We hope that you will

continue to add to our efforts to really fully understand what is

going on with these defined benefit plans and what is happening

at the PBGC.

Mr. Zimpleman?

26

STATEMENT OF LARRY ZIMPLEMAN, PRESIDENT, RETIREMENT AND INVESTOR SERVICES, PRINCIPAL FINANCIAL

GROUP, DES MOINES, IA, ON BEHALF OF THE BUSINESS

ROUNDTABLE

Mr. ZIMPLEMAN. Thank you, Senator Lott, members of the committee. It is a pleasure to be with you to speak to this topic today.

As you said, Senator Lott, I am Larry Zimpleman, president of

Retirement and Investor Services at Principal Financial Group in

Des Moines.

I am here today on behalf of the Business Roundtable, an association of CEOs from the largest employers in the world. The

American Benefits Council, the ACLI, the ERISA Industry Committee, the National Association of Manufacturers, the Financial

Executives Institute, and the U.S. Chamber of Commerce also

joined in my testimony today.

We commend Chairman Grassley, Ranking Member Baucus, and

all of you on the committee for having this hearing and for tackling

pension reform. Your leadership on retirement issues in recent

years has been invaluable, and we look forward to continuing to

work with you to build a sustainable and vibrant defined benefit

system.

Defined benefit plans cover over 34 million American workers today, and they have $1 trillion of assets invested in our capital

markets to support their benefit obligations. As we debate possible

changes to the funding rules, we need to find solutions that allow

for stable, predictable, and responsible funding rules.

In fact, we need to make changes that will promote greater defined benefit coverage, especially among smaller and medium-sized

employers.

There are several elements to the administration proposal that

we believe will be positive for creating a healthier defined benefit

system, particularly, improved disclosure to plan participants and

changed tax rules to allow plan sponsors to make larger contributions during good economic times. This is covered in detail in our

written statement.

However, my comments today will focus on those areas of the administration proposal that we believe deserve more study and

thought. As a starting point, our top two priorities for pension

funding reform are, first, making the long-term corporate bond rate

permanent. It is critical that employers be able to project pension

contributions beyond next year.

We also believe it is important to conform the interest rate for

lump-sum distributions to the same long-term corporate bond rate

so that plan funding is not harmed through the choice of lump-sum

distributions.

Second, we need to confirm the rules for hybrid defined benefit

plans, which today cover over 7 million American workers and

which provide appropriate alternatives to traditional defined benefit plan design.

Our written statement discusses the principles that we believe

should underlie pension fund reform. In the interest of time, I will

not repeat those principles here today, but I would like to touch on

the five specific areas of concern that we have with the administration proposal.

27

First, the administration proposal removes the ERISA funding

rules which are based on long-term, predictable results and replaces them with methodologies that are based on more of a spotrate methodology.

As a threshold matter, spot-rate methods do not mean tougher

funding standards than ERISA methods. However, the spot-rate

methods will cause more volatility in pension contributions and

will create greater cyclical effects on the U.S. economy.

Our written statement mentions economic analysis that we have

commissioned that estimates that, had the proposed funding rules

been in effect in 2003, it would have cost the U.S. economy over

300,000 jobs.

Second, the proposed funding rules advocate the use of a yield

curve for determining plan liabilities versus the current use of a

single rate, which is the long-term corporate bond rate, as I mentioned a minute ago. Since the yield curve is a more complex methodology, it is an issue, particularly for small and medium plans.

From the modeling we have been able to do on the proposal, we

also believe that if the yield curve were imposed today, it would

mean that the typical mature plan would see a decline in its funding status of approximately 10 percent, as the overall rate produced

by the yield curve is approximately 1 percent lower than the current long-term corporate bond rate.

If a yield curve methodology is to be used, it must be done in a

manner that produces an economic trade-off to a single rate for the

typical mature plan. The yield curve methodology must not be a

back-door mechanism to create lower interest rates for purposes of

determining the value of plan liabilities.

Third, it is not clear from the analysis that we have been able

to do that the administration proposal works well in periods of

higher interest rates, similar to what the U.S. economy experienced

in the 1980s. We believe that more work and analysis is needed in

this area.

Fourth, we acknowledge that the PBGC liability has increased in

the last few years, particularly since 9/11, but it is not clear that

the magnitude of the increased liability is as significant as has

been portrayed.

Even the PBGC acknowledges there is no near-term financial

issue. We believe that the best long-term solution for the financial

health of the PBGC is to have a healthy and growing defined benefit system, and we do not believe that this proposal will create

that.

We are particularly concerned about the PBGC proposal to introduce creditworthiness into the funding, premium, and benefit determinations. Not only are there practical issues, which we lay out

in our written statement, but the proposals ignore a basic principle

of U.S. pension law that requires plan assets be held in trust. So,

credit rate is not directly tied to a plan’s ability to pay promised

benefits.

Fifth, the PBGC proposes an increase in the base annual premium from $19 to $30, and to also index the base premium to wage

inflation. It also proposes to give the PBGC board the authority to

set the variable-rate premium at the level it believes is approVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 23367.000 SFINANC2 PsN: SFINANC2
28

priate. As we mentioned previously, it is not clear that the magnitude of the PBGC deficit warrants these major changes.

There is no question that moving the base premium up by over

60 percent will have a chilling effect on current defined benefit

sponsors or future employers who might otherwise consider establishing a defined benefit plan.

For example, our analysis indicates that small plans—which we

define, in this case, as plans under 100 lives—have not contributed

at all to the current PBGC financial deficit, yet they are being

asked to help contribute to fund the deficit.

As a matter of principle, we do agree with the Department of

Labor and PBGC that benefit promises must be funded. We support finding ways to prevent plan sponsors from making benefit

promises they do not intend to keep. However, we believe it is possible to create more targeted reforms to deal with PBGC’s financial

challenges.

Mr. Chairman and members of the committee, in making

changes to the defined benefit funding rules, it is vitally important

to recognize the impacts these changes can have on the U.S. economy, our capital markets, and the current employers who are participating in the defined benefit system today. Unintended consequences could be devastating.

As this proposal moves forward, we look forward to working with

this committee, the administration, and other regulatory agencies

to refine these ideas to achieve their intended results, while maintaining the overall health of our defined benefit system.

Thank you, Mr. Chairman, for allowing me to present the views

of the business community, and I would be happy to answer any

questions you might have.

The CHAIRMAN. Thank you, Mr. Zimpleman.

[The prepared statement of Mr. Zimpleman appears in the appendix.]

The CHAIRMAN. Now, Mr. Reuther?

STATEMENT OF ALAN REUTHER, LEGISLATIVE DIRECTOR,

UNITED AUTO WORKERS, WASHINGTON, DC

Mr. REUTHER. Thank you, Mr. Chairman. The UAW appreciates

the opportunity to testify before this committee on the administration’s pension proposals.

It is important to recognize at the outset that there is no immediate crisis at the PBGC. As the administration has admitted, the

PBGC has sufficient assets to pay all guaranteed benefits for many

years to come.

There also is general agreement that the PBGC’s projected deficit

is directly attributable to the widespread bankruptcies in the steel

and airline industries.

UAW supports balanced legislation to strengthen the funding of

pension plans and to bolster the PBGC, but we strongly oppose the

pension proposals advanced by the administration.

In particular, we oppose the funding proposals that would: mandate a yield curve interest rate assumption; establish new funding

rules based on spot valuations of assets and liabilities with no

smoothing mechanisms and with funding targets tied to a company’s credit rating; eliminate credit balances entirely; place arbiVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 23367.000 SFINANC2 PsN: SFINANC2
29

trary limits on benefits provided by pension plans; and prohibit

plans from even offering plant shut-down benefits.

In addition, we oppose the proposals relating to the PBGC that

would sharply increase the flat and variable premiums paid by

plan sponsors and link the variable premium to the credit rating

of a company, reduce the guarantees provided to workers and retirees, and give the PBGC a lien in bankruptcy proceedings for any

unpaid pension contributions.

The administration’s proposals would result in highly volatile

funding requirements, making it more difficult for companies to

plan their cash flow and liability projections.

In addition, these proposals would impose significant economic

burdens on many employers, punishing companies that are already

experiencing economic difficulties. The proposals would exacerbate

the competitive disadvantage facing many older manufacturing

companies with higher legacy costs.

The proposals also would discourage companies from contributing

more than the bare minimum during good economic times, and instead impose sharply higher counter-cyclical funding requirements

during economic downturns.

At the same time, the proposals would cut back benefits and

guarantees for workers and retirees, thereby reducing the adequacy

of their retirement income. The proposals would also cause many

retirees to lose their health insurance coverage.

Taken together, the UAW believes the administration’s proposals

would result in more bankruptcies, more plant closings, and job

and benefit loss. This, in turn, would lead to more pension plan terminations and the transferring of even greater unfunded liabilities

to the PBGC.

The proposals also would provide a powerful incentive for employers to exit the defined benefit pension system, to the detriment

of workers and retirees, and potentially creating a death spiral for

the PBGC.

Instead of these counter-productive proposals, UAW urges this

committee to approve a more balanced package of reforms that will

improve the funding of pension plans, thereby enhancing the security of benefits and reducing the future exposure of the PBGC without punishing employers, workers, and retirees.

This includes funding reforms that would make permanent the

long-term corporate bond interest rate assumption that was enacted last year; modifying the deficit reduction contribution rules

so they apply to a broader universe of plans and are triggered more

quickly when a plan becomes less than fully funded, but also provide a smoother path towards full funding; shortening the amortization period for plan amendments from 30 to 15 years; and requiring employers to value new credit balances according to actual

market performance.

In addition, the UAW supports the establishment of a new plan

reorganization process for under-funded plans in situations where

the employer has filed for chapter 11 bankruptcy.

We believe this type of process could be a powerful tool for enabling struggling employers, like many of the airline companies, to

be able to continue their pension plans while protecting workers

and retirees to the maximum extent feasible, but also preventing

30

unfunded liabilities from being transferred to the PBGC. Thus, this

approach would be beneficial for workers, retirees, for companies,

and for the PBGC.

Finally, the UAW believes the best way to deal with the steel

and airline liabilities that have, or will be assumed by the PBGC,

is to have the Federal Government finance these liabilities over a

30-year period.

This would be far less costly than the administration’s own proposal to increase significantly the amounts that can be contributed

to individual retirement and savings accounts.

In our judgment, this would be far better for workers and retirees, for employers, for the PBGC, and the entire defined benefit

pension system than the administration’s proposals.

In conclusion, the UAW appreciates the opportunity to testify before this committee, and we look forward to working with the members of this committee as you consider these issues. Thank you.

The CHAIRMAN. Thank you, Mr. Reuther.

[The prepared statement of Mr. Reuther appears in the appendix.]

The CHAIRMAN. Now to Mr. Kroszner.

STATEMENT OF RANDALL S. KROSZNER, PROFESSOR OF ECONOMICS, THE UNIVERSITY OF CHICAGO GRADUATE SCHOOL

OF BUSINESS, CHICAGO, ILLINOIS

Mr. KROSZNER. Thank you very much, Mr. Chairman, Senator

Lott, and the members of the committee. I am delighted to be able

to speak about these issues before you.

I applaud the committee for taking up this very, very important

and complicated issue at this time because I believe the system is

in crisis and in urgent need of fundamental reform. It is a ticking

time bomb waiting to explode. The longer we wait to defuse it, the

more costly it will be for everyone.

What I want to do is draw some parallels between what happened in the savings and loan industry and with PBGC today. I

call this section ‘‘Deja Vu All Over Again: Don’t Let the PBGC Become the S&L Crisis of the New Millennium.’’

In my more detailed written remarks, I go through many of the

parallels between the Federal Savings and Loan Insurance Corporation—the so-called FSLIC—and the PBGC of providing insurance guarantees, not allowing the premiums to vary with risk, seeing a series of economic shocks that happened in the savings and

loan industry that have also happened in the broader economy recently to push the insurance agency into deficit.

But, as I note, one of the most disturbing parallels is that many

observers, both back in the 1980s for the FSLIC, and for the PBGC

today, acknowledge that the agencies face some challenges currently, but they said that the trouble is simply a temporary phenomena.

As the economy recovers, everything will be fine. Just wait and

hope with fingers crossed. This is the so-called forbearance policy

that ended up costing American taxpayers $100 billion in the savings and loan industry.

The sad history of the thrift crisis demonstrates that we should

not wait, we must act now. Why? Because the problems will only

31

grow larger. As you heard from the earlier panel, there are sizeable

deficits currently at PBGC. The projected deficits, both by PBGC

making reasonable assumptions and other nonpartisan agencies,

are on the order of $90 to $100 billion.

The reason that this will grow is that there is a moral hazard

problem that is a bad incentive problem of the current system for

employers to take excessive risks, for employers to under-fund their

pension obligations and to issue larger pension benefits as the company is getting into difficulty, trying to make a trade-off, offering

up the Pension Benefit Guaranty Corporation’s guaranteed benefits

when they do not have the cash today, and the shut-down benefits

that can then be guaranteed by the PBGC. These are all classic examples of moral hazard problems.

We have seen, in the airline industry, a number of examples of

unions taking out lump-sum benefits just before bankruptcy, or

even as firms are entering bankruptcy, taking the money out as

quickly as possible. Again, another classic problem of moral hazard.

To avoid an enormous and inappropriate taxpayer-financed bailout of the PBGC at some point, action must be taken swiftly. I

think we have the blueprint for that before us.

The Senate has, little more than a decade ago, passed the Federal Deposit Insurance Corporation Improvement Act, the so-called

FDICIA, of 1991. It introduced a number of important changes that

dramatically reduced the problems, and we have not had problems

in the savings and loan industry or in the broader banking industry since.

Even though we have had recession, we have had 9/11, we have

had a number of shocks, with volatility in interest rates, the industry has stayed quite healthy through this.

What are these steps that FDICIA had, and how can they be applied to the current situation with PBGC?

First, FDICIA permitted insurance premiums to increase to provide greater assets for the Deposit Insurance agency to cover its obligations. This is an important first step. Put the insurance agency

on a solvent basis.

How do you do that? By charging actuarially fair premiums. If

there are greater risks, you pay more. That is the appropriate

thing to do. The overall level needs to rise.

Second is the specific adjustment for risk. Right now, we do not

have appropriate risk adjustments in the system, so this is a terrible penalty for the good actors, for the employers who are doing

the right thing, who are funding their pensions well, who are acting in the right way.

What you need to do is reward those people, and punish the people who are undertaking riskier activities, who are doing things

that are putting the pension system at risk, by charging higher returns.

So, taking into account things like the risks in the asset portfolio,

the likelihood of PBGC take-over, such as the probability of financial distress, the extent of the funding gap, are perfectly reasonable

things to do.

In addition, what FDICIA did is prompt corrective action. And

Senator Lott brought up exactly these issues before. Why is the

PBGC not acting earlier? Well, they do not have the legal authority

32

to do so. The regulators did not have the legal authority to do so

during the savings and loan crisis. However, what FDICIA did is

allow for prompt corrective action.

When plans are going down and getting into trouble, what do you

do? You start to put restrictions on the activities. You do not allow

for the ability to pull out lump-sum transfers. You do not allow for

the ability to offer more shut-down benefits that are guaranteed by

the PBGC. So what you need to do is restrict the activities when

the moral hazard problems, when the risks, are greatest to the taxpayer.

In conclusion, what I would like to say is that we need to think

more broadly here on these issues, I think, to explore some options

that might involve greater harnessing of private-sector involvement

in order to maintain the security of the pension system without encouraging undue risk.

One question that arises is whether government-sponsored enterprise is the best way to achieve these objectives. For instance, the

Congress has successfully moved Sallie Mae from a governmentsponsored enterprise that guarantees student loans into the private

sector. In the home mortgage area, private mortgage insurers provide guarantees to allow many purchasers of homes who otherwise

could not receive a mortgage.

Investigating the feasibility of some forms of private insurance

over the purchase of private annuities by employers for their employees would be a valuable addition to the immediate reforms of

the PBGC.

Thank you very much for the honor of allowing me to express my

views before the committee, and I would be happy to answer any

questions you might have.

[The prepared statement of Mr. Kroszner appears in the appendix.]

The CHAIRMAN. All right.

Now, if I do direct questions to any one of you, since we do have

a diverse panel and opinions, if anybody wants to enter in, you can

enter into the discussion. We do not have anything to hide here,

and we want to get all the opinions out on the table.

I am going to start with Mr. Reuther. In your prepared statement, you make the argument that because we bailed out the savings and loan situation, we should also be willing to bail out PBGC.

I think most people would say that we ought to be doing everything we can to avoid such a bail-out like that in the future, particularly by the taxpayers. Should we not be taking steps now to

avoid another savings and loan situation?

Mr. REUTHER. Yes. That is why we suggest that there should be

a balanced package of funding reforms to improve the funding in

the rest of the defined benefit system. That would be good for

workers and retirees and would reduce the exposure of the PBGC.

But you still have the question then, what do you do about the

steel and airline liabilities that have already been put on the system?

Our point is, trying to push those costs onto other employers, the

rest of the premium payers, will be counterproductive and will really, in the end, cause a death spiral in the overall defined benefit

pension system.

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The CHAIRMAN. Anybody else want to enter into that?

Go ahead, Mr. Kroszner.

Mr. KROSZNER. If I might, Mr. Chairman. It is extremely important to avoid what happened in the 1980s with the savings and

loan crisis. We must avoid the taxpayer-financed bail-out. As the

head of the PBGC said, there is no obligation on the part of the

government to do so, but there may be pressures to do so.

The best way to do it is to pursue exactly what the Senate and

House did in 1991, set in a series of protections that will reduce

the likely exposure of the taxpayer, reduce the risks in the system.

The FDICIA is a good model for that.

I think many of the administration’s proposals that involve reducing the ability to take out lump-sum transfers, to provide shutdown benefits guaranteed by the PBGC as a firm is getting into

trouble, are exactly in the right direction. Protect the taxpayer. We

can do it, but we need to act now.

The CHAIRMAN. I would like to have each of you respond to this.

This is the so-called ‘‘perfect storm’’ situation for pension funding

that is said to be the result of historically low interest rates and

the bear market after the late 1990s stock boom.

Today, though, we have seen 2 years of rising stock markets. For

much of the last 2 years, we have seen stock prices really rise quite

dramatically, from their low, at least. In addition, interest rates

have stayed low for a considerable period of time. Many experts believe that interest rates may stay quite low into the future.

In other industrialized nations, major countries like Japan and

Europe, interest rates are often even lower. Is the ‘‘perfect storm’’

analogy really correct in today’s environment?

Mr. ZIMPLEMAN. Well, Senator, I will make a couple of comments

on that. I mean, I think as you evaluate the current deficit, whatever level that may be, of the PBGC—I know they’ve reported it

at $23 billion, and as the information around, whether it is $450

billion of under-funding or whatever the level is purported to be—

I think it is important, quite frankly, to recognize what we are

using as our measuring stick and to recognize that, as we look at

the change—for example, the change in PBGC liability from only

3 or 4 years ago when it was $9 billion in surplus to $23 billion

in deficit—I think it does beg the question as to what percentage

of that change is a result purely of interest rate changes, and what

part of that change is attributable to new termination liabilities

that PBGC has taken on.

So I would argue that, in crafting solutions to this, it is important to be very judicious and to be very detailed and not to overreact to the particular moment in time where we sit with interest

rates.

The CHAIRMAN. Mr. Reuther, if not being repetitive, I would like

to have your comment.

Mr. REUTHER. It is important that there be a proper valuation

of the PBGC’s liabilities, but we do not think this is something that

will just go away as interest rates change. As I indicated before,

we think there is a need to strengthen the funding of plans.

But also, getting back to, why does the PBGC have this deficit,

there is just no denying that something happened in steel and in

airlines that was different than anything they had ever seen beVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 23367.000 SFINANC2 PsN: SFINANC2
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fore. We think Congress needs to take that into account in deciding

how to deal with this.

The CHAIRMAN. Mr. Kroszner?

Mr. KROSZNER. Well, people had made precisely the same arguments in the early 1980s: this is just a special circumstance with

respect to interest rates; things will get better, we just need a little

bit more time. The problem was, we had more time and the problem grew greater.

There are certain special circumstances at any particular point

in time, but the fundamentals are wrong in the way that the PBGC

is set up. There is a fundamental moral hazard problem and that

needs to be addressed.

The CHAIRMAN. Mr. Zimpleman, Principal Financial has had

great success as a leader in delivering retirement plans to businesses and individuals around America. Principal has also had particular success in hard-to-reach small- and medium-sized company

markets. Are there ways, unrelated to pension funding rules, that

Congress could help promote new defined benefit plan sponsorships?

Mr. ZIMPLEMAN. I think that is a critical question, Senator, because as was noted in the introductory comments, we have gone

from 112,000 defined benefit plans 20 years ago to 33,000 plans

today, and that has certainly been a contributing factor.

I would again go back and talk, as I said before, about the need

for predictability, stability, and responsibility in pension funding.

We think, again, our modifications to the administration proposal

would help us achieve that.

The second thing is, I think we need to confirm the legality of

hybrid plans. Again, I mentioned that in my statement.

The last point I would make is, I think there are some new and

innovative defined benefit types of plan designs. For example, we

have crafted, working with other actuarial groups, what we call our

DBK proposal that allows for a combination of defined benefit and

defined contribution programs in a single, integrated package.

We are very excited about that, particularly for small employers,

although it would take legislative changes to accomplish that, and

we appreciate your support and consideration in the new NESTEG

bill. Thank you, Senator.

The CHAIRMAN. For Mr. Reuther and Mr. Zimpleman: in your remarks, you argue that the long-term corporate bond rate is an appropriate replacement for the 30-year Treasury rate.

The yield curve, which was approved by our committee last year,

was based partly on interest rates, and partly on the duration of

the liability being funded. In other words, you would use a lower

interest rate for shorter-term liabilities and a higher interest rate

for longer-term liabilities.

This is a concept that anyone who has taken out a mortgage

would understand. Why should companies with younger workforces

fund their pension plans under the same assumptions as companies

with significantly older workforces? Either one of you can start.

Mr. REUTHER. When you talk about accuracy, we think it is a

mistake to only look at interest rate assumptions. There is also the

mortality assumptions. It is interesting that the administration has

not come forward and said that companies ought to be allowed to

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use collar-adjusted mortality tables that would also be more accurate and would recognize, if a company has a blue-collar workforce,

more older workers and retirees, that the mortality may be different.

So it seems to us that the administration is being one-sided in

its accuracy pronouncements, and it is trying to do that with an

eye toward producing things that will help their balance sheet, but

are not necessarily in the interest of employers who are trying to

maintain the plans, and the workers and retirees.

The CHAIRMAN. Mr. Zimpleman?

Mr. ZIMPLEMAN. Well, Senator, I guess my response to your question would be that the key, whether it is a single rate or yield

curve, is really to settle on a methodology that provides a longterm, permanent fix to this particular issue.

I mean, I think that is really the key at the end of the day. The

question of whether it is a single rate or a yield curve is something

I think that the experts can debate.

I would say, however, that it is not yet clear to us that the extra

precision of the yield curve methodology and the complexity of the

yield curve methodology generates that much additional value in

the calculation of plan liabilities to warrant the complexity, but

that is certainly a discussion that we can have.

The CHAIRMAN. Yes.

I am going to ask this question of Mr. Zimpleman, but if other

people would want to give their perspective, that would be fine. I

ask from the standpoint of you being an actuary and representative

of an insurance company. You have, of course, vast experience

here.

Certainly, the insurance hazards that PBGC faces would not be

acceptable to any insurance company. Why should Congress allow

the PBGC to continue to function on such an unsound insurance

basis that you could not function under?

Mr. ZIMPLEMAN. I thought, Senator, if I came here all the way

from Iowa you would ask me the easy questions instead of asking

me the hard questions. [Laughter.]

The CHAIRMAN. Listen, what about a week ago yesterday, all the

tough questions you asked me?

[Laughter.]

Mr. ZIMPLEMAN. Yes. I did not have this big of an audience,

though, Senator. [Laughter.] Well, again, I think it is a great question. Let me make, perhaps, a few points about that.

As I said in my statement, there is a deficit at PBGC. There is

no question about that. The magnitude of that deficit is not exactly

clear, but the deficit is larger and it has increased as a result of

9/11.

I think, however, it would be somewhat dangerous for us to think

about the PBGC and its operations on exactly the same plane as

a commercial insurer. I mean, I do think there are legitimate reasons that you would evaluate those two situations somewhat differently.

PBGC is a government-sponsored entity, as Dr. Kroszner noted.

They do perform, I believe, a very valuable public stewardship role,

and quite frankly have been quite successful over 30 years.

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I think that the key here is to restore the financial health and

vibrancy of the defined benefit system, and at the end of the day

the focus should be more on that than it should be trying to create

solutions that are based on, as Mr. Reuther has noted, a couple of

industries that we all know are in great distress.

So, we would rather put the solution on creating a vibrant and

healthy defined benefit system, having hybrid plan design be a legitimate approach, and looking for new and innovative ways, such

as DBK, quite frankly. I think growth is the best long-term solution.

The CHAIRMAN. Mr. Reuther?

Mr. REUTHER. If I may. I agree with those comments. Congress

did not establish the PBGC because it wanted to operate a private

insurance company. It was looking at how it could protect the pension benefits of workers and retirees and promote the defined benefit pension system. We think those should continue to be the central focus of Congress.

The CHAIRMAN. Mr. Kroszner?

Mr. KROSZNER. If we look back at the origins of the PBGC, look

how Congress decided it should be funded. It should be self-funded.

It should not be drawing on taxpayer liability. So, I think your

original question of, why should this be operating on a different

basis than a private-sector institution is an important one.

I think the original intent of Congress was that it would be selffinancing, as profitable, private-sector institutions are. It should be,

and exposing the taxpayer to these risks is completely inappropriate.

The CHAIRMAN. All right. I thank all of you. That is my last

question. I appreciate your participation.

I did not announce this for the first panel, but they might be acquainted with it. Sometimes you get questions in writing from people that cannot be here, or even follow-up from people who have

been here. We would appreciate a response about 2 weeks after you

receive the questions. Thank you all very much.

[Whereupon, at 4:12 p.m., the hearing was concluded.]

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A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

PREPARED STATEMENT OF HON. BRADLEY D. BELT

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RESPONSE TO A QUESTION FROM SENATOR BAUCUS

Question: Assuming the administration’s funding proposal were adopted, but

PBGC was not given authority to set the variable rate, what rate per $1,000 would

you recommend that Congress adopt?

Answer: The reason the administration proposes that the PBGC board of directors

set the variable-rate premium level based on market conditions and the financial

condition of the insurance fund (as is the case with the FDIC) is that a single statutory rate will inevitably be too low or too high. The last time that Congress adjusted

the variable-rate premium was in 1994. While the rate may have been appropriate

at that point in time, it has proven to be substantially less than needed to cover

actual losses and future expected claims. The role of risk-based premiums under the

administration’s proposal is to provide the pension insurance program with the

amount of total premium revenue necessary to meet expected future claims and to

retire the program’s deficit over a reasonable time period. The proposal calls for the

premium rate per dollar of under-funding to be reviewed and revised periodically

by the PBGC board consistent with meeting these goals. The risk-based rate adjustments would be computed based on forecasts of expected claims and of the future

financial condition of the insurance program.

The budget numbers for the administration’s funding proposal reflect a risk-based

premium rate of $8–$9 per $1,000 of under-funding assuming that all under-funding

is assessed, that the flat-rate reforms are enacted, and that premium revenues are

to cover expected future claims and to amortize the $23-billion deficit over 10 years.

RESPONSES TO QUESTIONS SUBMITTED BY SENATOR BAUCUS

ON BEHALF OF SENATOR KEN SALAZAR

Question: Since United Airlines announced its intention to terminate the defined

benefit pension plans of its employees, thousands of hard-working pilots, flight attendants, and machinists who were promised future pension benefits have discovered that the pensions they have earned may be lost because they are much larger

than benefits guaranteed under our government’s pension insurance program. This

news has caused great anxiety and apprehension among Colorado households and

other households that planned on the pension benefits they were promised from

United Airlines.

You took action to terminate the United Airline’s pilot’s plan. At what point in

the process do you begin communicating directly with the beneficiaries?

As the termination progresses, what steps will you take to inform United pension

beneficiaries of the status of their pension benefits under the government program

and to ensure a smooth transition of benefits for these individuals?

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Answer: Termination of under-funded pension plans can have harsh consequences

for workers and retirees. When plans terminate, workers’ and retirees’ expectations

of a secure future may be shattered because, by law, not all benefits promised under

a plan are guaranteed. The PBGC tries to minimize participants’ anxieties by making the transition to the PBGC insurance program as smooth and transparent as

possible.

In the case of the United Airline’s pilots’ plan, PBGC trusteeship of the plan is

awaiting court approval or the company’s execution of a trusteeship agreement. Although the PBGC has been engaged in discussions with the company and unions

for many months, it has no access to participant records until after it takes over

as trustee. As soon as PBGC trusteeship occurs, we will send a letter to all participants informing them that PBGC has become responsible for their plan. The letter

will explain that retirees will continue receiving benefits without interruption while

the plan’s records are reviewed, and that both retirees and other participants who

apply for retirement in the near future will receive estimated benefits payable to

them under law. Prior to trusteeship by PBGC, participants may obtain general information about what happens when PBGC takes over a plan by calling the PBGC’s

customer information center or visiting the PBGC’s website.

Within a few months of trusteeship, PBGC will have calculated estimated benefits

for retirees whose benefits will be reduced. PBGC will send retirees a statement of

their estimated benefit amounts and will reduce monthly payments to estimated

amounts a month or so later. At about the same time, PBGC will hold participant

meetings in cities with the largest participant populations to discuss the plan’s benefit provisions, PBGC’s administration of the plan, and benefit guarantees and limitations. At these meetings, retirees have an opportunity to ask specific questions

about their estimated benefit statements. (In 2004, PBGC held 195 meetings that

were attended by 23,743 participants.)

Vested participants who are not yet eligible to retire may request an estimate of

their benefits at any time after trusteeship, but final benefit statements may take

up to 3 years after trusteeship. Prior to issuing final benefit statements, PBGC collects and audits plan and participant records, reconstructs missing records, calculates each participant’s benefit and the effect of PBGC’s maximum guarantees

and other limitations, obtains any recoveries from the company, and values and allocates plan assets and recoveries to benefits.

PBGC’s ability to make timely benefit determinations depends in large measure

on the quality of the records maintained by the sponsor, and, unfortunately, we’ve

encountered situations in the past where record maintenance has been poor.

If a participant wishes to retire before final benefit amounts have been determined, the PBGC will pay an estimated benefit. Underpayments and overpayments

will be corrected after final benefit calculations are completed. Participants are entitled to appeal the PBGC’s final benefit determinations.

Question: The Federal Aviation Administration requires commercial pilots to retire at age 60. However, the PBGC statute penalizes employees who retire before

age 65 by decreasing the maximum pension benefit amount guaranteed. The consequences of these conflicting laws are grave for many United Airlines pilots. Not

only will they not receive the full pension benefits promised by United Airlines, but

they will be penalized further by the government-guaranteed pension they do receive—for obeying the law and retiring at age 60.

Do you believe that the interaction of these two laws is consistent with the spirit

and mission of the PBGC?

Are you aware of any other job categories that are similarly impacted by the reduction for retirement before age 65?

Answer: We do not believe that the interaction of these two laws is inconsistent

with the spirit and mission of the PBGC. The maximum guarantee limit established

in ERISA is reduced where a retiree is younger than 65 when his or her plan terminates, because a benefit commencing at an earlier age is paid over a longer period

of time than the same benefit amount commencing at 65. The reduction applies to

any retiree who is younger than 65 at termination, not just to pilots. Indeed, thousands of steelworkers and other participants who retired in their 50s or early 60s

have had their benefits reduced because of this rule. Generally, pilots may not fly

commercially after age 60. However, they can—and often do—continue working

after age 60 in other capacities. Participants whose benefits would be cut by the

maximum guarantee because of age and who have not yet started their pensions

when the plan terminates may choose to wait until age 65 to begin payments. We

also note that Social Security operates in the same way as the PBGC maximum

guarantee limit: a person who commences his or her Social Security benefit at age

62 receives a lower benefit than if he or she waited until 65 or a later age. This

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age reduction in Social Security benefits is made for the same reasons as the age

reduction in PBGC’s maximum benefit.

RESPONSE TO A QUESTION FROM SENATOR HATCH

Question: Mr. Belt, in your testimony you stated that in the worst case, PBGC’s

deficit could grow so large that the premium increases necessary to close the gap

would become unbearable to responsible premium payers. You hinted that a taxpayer bailout might then become necessary. At what point does the PBGC deficit

approach this critical stage? Are we close to it now? Could we get into a situation

where stronger companies now paying premiums become concerned enough to freeze

or terminate their own defined benefit plans, not because they are worried about

being able to keep funding them, but because they are concerned about being stuck

with unfair premiums brought on by so many other companies failing?

You mentioned that PBGC’s first statutory mandate is to encourage the continuation and maintenance of voluntary private pension plans. It seems to me that the

current problems facing defined benefit plans, if they continue to worsen, could deteriorate into an outright crisis. Add to this the problems that hybrid pension plans

are facing, and the outlook for DB plans looks quite bleak. I have two questions.

First, do you think the defined benefit pension plan system is in crisis, and, second,

what are the critical steps Congress must take this year to prevent a taxpayer bailout and/or the end of the DB system?

Answer: Enacting the administration’s pension reform proposals is a critical step

to revitalize the DB system and to restore the pension insurance program to financial health. The administration believes that the companies that make promises to

their employees should fund those promises. Inevitably, there will be incidences of

default, and losses will occur. One of the objectives of the administration’s proposal

is to ensure that when plans do terminate, they are not substantially under-funded.

The problem is that the current funding rules don’t work and have allowed companies to terminate plans with large, in some cases, multi-billion dollar deficits. As

a result, PBGC’s deficit has grown to more than $23 billion, and the insurance program is facing tens of billions of dollars of additional exposure. Under current law,

the PBGC has insufficient resources to meet its commitment to participants over the

longer term, and the financial integrity of the insurance program is likely to be further impaired without comprehensive reform of the funding rules.

With respect to your question about the willingness of stronger companies to continue to maintain their defined benefit plans if PBGC’s deficit grows, the administration’s proposals would provide the necessary reforms to strengthen the system so

that strong companies would not exit. The proposed premium structure would make

it possible for PBGC’s board to increase premium revenues enough to fund expected

future claims and retire the existing single-employer program deficit over a reasonable period of time. Premiums would more fairly reflect the risk that each plan

poses to the system than under the current structure. The proposed structure would

eliminate unfair exemptions from risk-based premiums, and would set risk-based

premiums based on a more accurate measurement of plan under-funding that reflects the financial health of the plan sponsor.

The term ‘‘crisis’’ is an oft-overused one, but there clearly are significant challenges facing the defined benefit system and insurance program. In addition to the

premium reforms, other structural reforms are needed. First, the administration’s

proposals for basic funding reforms are essential to ensuring that pension plans are

adequately funded and benefit promises are kept. The administration’s proposal

would use more accurate measures of assets and liabilities, and base funding targets

on the plan sponsor’s financial health. It would eliminate contribution holidays that

arise from current credit balances and allow plan sponsors to make additional deductible contributions during good economic times. It would also improve disclosure

to workers, investors and regulators, and reform the pension insurance premium

structure. Second, the issues surrounding cash balance plans must be addressed in

order to provide stability and certainty to employers.

RESPONSES TO QUESTIONS FROM SENATOR ROCKEFELLER

Question: I am very concerned with some of the administration’s suggestions for

limiting benefit increases and accruals. It seems to me that these changes would

punish workers in cases where company management fails to invest enough money

in the pension plan.

The administration has claimed that these benefit restrictions would prompt

workers to put pressure on employers to better fund pension plans. However, it is

not clear to me how workers could effectively stop employers from under-funding

plans.

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I would like to hear how you expect workers to protect themselves, and please

specifically address how they could do so between contract negotiations as their benefits are being cut.

I would also like to know what would prevent an employer from purposely underfunding the pension plan in order to deprive workers of hard-won pension benefit

increases?

Answer: The administration believes that we must ensure that companies make

only benefit promises they can afford, and keep the promises already made by appropriately funding their pension plans. When companies are unable to keep their

pension promises, the losses are shifted to the pension insurance system and to

workers. It is these empty promises that harm workers by putting their retirement

security at risk. The new stronger minimum funding rules combined with the proposed limitations will prevent companies from making hollow promises.

The stronger minimum funding rules will prevent employers from purposely

under-funding their pension plans. Companies will be required to fund their plans

up to a meaningful funding target. Companies that fall below the minimum funding

target will be required to fund up to the target within a reasonable period of time.

A plan sponsor that is operating outside of bankruptcy cannot ignore its funding obligations without serious consequences. There are significant enforcement measures

available to the IRS and the PBGC to prevent firms from ignoring funding obligations.

The proposed benefit limitations will apply only when a plan’s funded status falls

below acceptable levels. The limit on benefit increases for certain under-funded

plans will prevent companies from promising additional benefits unless promises already made to workers are adequately funded. The limit on accruals will apply only

for plans with severe funding shortfalls or sponsors in bankruptcy with under-funded plans. The limitations will not affect benefits already earned. Rather than deprive workers of hard-won pension benefit increases, we believe that these proposals

create a strong incentive for employers to adequately fund their plans—making it

more likely that workers’ retirement expectations will be met. Our proposal takes

into account existing collective bargaining agreements by not applying these benefit

limitations until the earlier of the end of the contract term or 2009.

Plans that become subject to any of the benefit limitations will be required to notify affected workers, making them aware that deteriorating funding is threatening

their benefits. Workers need this information so that they can have realistic expectations about their company’s ability to fund pension promises. We also believe that

in some instances, companies will improve the funding of their plans in order to

avoid notifying workers and thereby creating worker dissatisfaction.

Question: I am very concerned that the administration has made no proposal to

address the pension crisis in the airline industry. A considerable amount of the deficit facing the PBGC is expected to derive from failing airline pension plans. Yet

the administration has proposed no remedies specific to that industry that would

help airlines maintain their plans.

Some airlines have asked Congress to consider relief that would allow them to essentially restructure their pension plans. By giving the companies a longer time period to pay off debt and perhaps limiting the PBGC’s exposure to increases in pension liabilities, airlines may be able to save their pension plans.

What industry-specific relief is the administration willing to consider to protect

the pension benefits of airline employees and help the companies maintain promises

they made to their workers?

Answer: We understand the financial difficulties the airlines are facing. Congress

and the administration have provided assistance to the airlines in the form of

grants, loan guarantees, and short-term funding relief when such assistance was determined to be appropriate.

The administration’s pension reform proposal would strengthen the funding rules

to improve the health of the entire defined benefit pension system. This is particularly important for those under-funded plans that pose the greatest risk of terminating. Neither the defined benefit system nor the pension insurance system is designed to provide or capable of providing targeted relief to specific industries. It is

designed to insure benefits for participants in plans that fail.

Relaxing the funding rules for a specific industry would set a dangerous precedent

for the pension insurance program. We do not believe that the interests of participants, other premium payers, or the taxpayer are best served by allowing companies

to effectively borrow from their employees and the insurance fund to meet their financial obligations.

I would also emphasize that the majority of losses incurred by the PBGC to date

have been in industries other than airlines and that the majority of the insurance

fund exposure to ‘‘reasonably possible’’ claims is in other industry sectors. So, the

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* Cooper v. IBM Personal Pension Plan, 274 F. Supp. 2d 1010 (S.D. Ill. 2003) (holding that

cash balance plans violate age discrimination provisions of ERISA). Other courts, however, have

disagreed. Tootle v. ARINC, Inc., 222 F.R.D. 88 (D. Md. 2004); Eaton v. Onan Corp., 117 F.

Supp. 2d 812 (S.D. Ind. 2000).

financial pressures on the pension insurance program are not unique to the airline

industry.

Current law allows plan sponsors to obtain funding waivers if they are experiencing temporary substantial business hardship. The IRS can, in consultation with

the PBGC, and often does, impose conditions on obtaining a waiver that protect the

interests of participants and the pension insurance program.

Question: I appreciate the difficulty we are facing in trying to shore up the defined

benefit pension plan system. On the one hand, we want to better protect workers

by making sure that employers are adequately funding their pension promises. On

the other hand, we want to encourage employers to continue to provide defined benefit pensions that protect workers and retirees from the risks associated with the

stock market.

I am very concerned that the administration’s proposal focuses just on addressing

the deficit faced by the PBGC. Many aspects of this proposal would increase funding

to the PBGC, but actually make it much harder for employers to maintain these

plans.

For example, the yield curve proposed by the administration would be much more

volatile and difficult for employers to predict and plan for. The yield curve also substantially increases the liability calculations for industries that have older workers.

Even healthy plans would see substantial premium increases under the administration’s reforms.

I am concerned that these are shortsighted fixes to the PBGC’s funding problems.

As defined benefit plans become more and more expensive for employers, many companies will simply shift away from offering such pensions. As healthy plans voluntarily terminate, the funding problems in the system increase, creating a vicious

cycle.

How does the administration propose to encourage companies to continue to offer

defined benefit plans?

Answer: We would respectfully disagree that the administration’s proposal focuses

just on improving the pension insurance program deficit or that it would or should

cause employers to abandon their pension plans. We believe the proposal appropriately balances competing considerations. The objective is to ensure that plan

sponsors honor the promises they have made, and the proposal requires companies

to make up their funding gap over a reasonable period of time. At the same time,

the administration’s proposal provides additional flexibility for plan sponsors and

provides numerous incentives for them to maintain and prudently fund the plans

they sponsor.

For example, companies will be able to make much larger tax-deductible contributions to their plans during good economic times than under current law. Companies

that contribute more than the minimum requirement would effectively shorten the

amortization period. They would be able to reduce the amount of risk-based premium that would have to be paid. And companies would likely benefit from improved credit ratings if they reduced their unfunded pension liability, thus lowering

their cost of capital.

We also do not agree that the administration’s proposal would lead to greater volatility and make it more difficult for companies to predict their funding requirements. The risk and volatility in the pension plan is a function of the business decisions made by the company. Current law simply masks that volatility and allows

companies to shift the risks to third parties. It is because of current-law features

like smoothing and credit balances that plans sometimes are so under-funded when

they terminate. Hiding the problem doesn’t make it go away. There are numerous

ways under the administration’s proposal in which companies can minimize risk and

volatility and make funding more predictable.

The administration also believes that Congress should act promptly to clarify the

legal status of cash balance and other hybrid pension plans. The only new defined

benefit plans created in recent years have been alternative benefit structures, such

as cash balance or pension equity plans that are designed to meet the needs of a

younger, more mobile workforce. Unfortunately, as a result of a single Federal court

decision, the legal status of these types of plans is in question.*

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RESPONSES TO QUESTIONS FROM SENATOR SMITH

PAYOUT OPTIONS

Question: So many of the demographic figures I have seen lately speak to the fact

that more and more of the responsibility for accumulating retirement savings is

shifting to the individual. Half of American workers get help from their employers

in the form of employer-provided savings, and half of our workers must do it on

their own. Of course we’re here discussing some of the ways to achieve further security for those who do have such access to traditional pensions and what can be done

to make them more secure.

I have actually introduced legislation that would give the same guaranteed payout

streams as traditional pensions to those who do not have access to such employerprovided plans. What the legislation provides is an incentive to consider the ‘‘delayed gratification’’ of an annuitized payout you can’t outlive when compared

against the ‘‘instant gratification’’ of receiving a simple lump sum.

The reason why I raise this issue is that even the defined benefit pension plans

we are discussing today are trending increasingly toward paying lump sums at retirement; in particular, cash balance plans. For those of us concerned that retirees

need to consider taking a guaranteed payout stream rather than just a lump sum,

what can you tell me about your plans that will create some payout options for retirees?

Answer: The administration’s funding proposal will strengthen and preserve the

defined benefit system. Preserving the system will enable more workers to have the

option of taking their pension distributions in the form of annuities. The administration’s proposal also eliminates an inappropriate incentive for participants to take

lump-sum distributions.

Under current law, the use of an inappropriately low discount rate for determining the value of lump sums creates an incentive for participants to choose lump

sums. Under our proposal, the yield curve would be used to calculate minimum

lump sums, which will eliminate this distortion that can bias a participant’s payout

decision toward lump sums. This reform includes a transition period, so that employees who are expecting to retire in the near future are not subject to an abrupt

change in the amount of their lump sums as a result of changes in law. The new

basis would not apply to distributions in 2005 and 2006 and would be phased in

for distributions in 2007 and 2008, with full implementation beginning only in 2009.

MULTIEMPLOYER PLANS

Question: It is my understanding that the administration is not planning on taking any action on multiemployer plans in the near future. However, there is a crisis

brewing among the multiemployer plans as well. Some very large plans are close

to having to go into ‘‘reorganization,’’ and many retirees in my State of Oregon will

be impacted. Does the administration plan on reporting to us on the risk that the

multiemployer system would have to assume if some of these multiemployer plans

become insolvent?

Answer: The administration recognizes that changes in the multiemployer funding

rules are necessary. However, we focused on single-employer plans first because the

problems facing single-employer plans are more immediate and acute. Also, due to

the unique nature of multiemployer plans, not all elements of the single-employer

proposal could be immediately applied to multiemployer plans. We believe it is vitally important that Congress enact legislation to protect the retirement security of

workers in these single-employer pension plans. At the same time, however, we

must remember that there are millions of Americans who are covered by multiemployer pension plans, and that their retirement security is equally important. We

should work together in a bipartisan fashion to ensure that multiemployer plans are

strengthened.

The multiemployer insurance program covers about 9.8 million workers and retirees in about 1,600 plans. The program has only one source of funds, an annual premium payment of $2.60 per participant that generates about $24 million of income

per year.

The PBGC insurance comes into play when a multiemployer plan becomes insolvent—that is, when the plan does not have enough assets to pay benefits that fall

under the statutory limit, which was originally set at less than $6,600 per year for

a retiree with 30 years of service. In 2001, Congress amended the law to double the

limit—to $12,870 per year—but did not increase the premium. Between 1980 and

2000, relatively few multiemployer plans failed; the agency paid out $167 million

to some 33 plans.

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Recently, however, more plans have failed. In its 2004 Annual Report, PBGC estimates that financial assistance payments to multiemployer plans denoted as

‘‘probables’’ will reach $30 million in 2005, $90 million in 2006, and $100 million

per year for at least a decade thereafter. In addition, it is ‘‘reasonably possible’’ that

other multiemployer plans will require future financial assistance in the amount of

$108 million in present-value terms.

The multiemployer program ran surpluses for over 20 years until it recorded its

first deficit of $261 million in FY 2003. The multiemployer program reported a deficit of $236 million in FY 2004. This is in contrast to the $23.3-billion deficit in the

single-employer program.

In the 2004 Annual Report, PBGC estimated that, as of September 30, 2004, the

total under-funding in insured multiemployer plans is more than $150 billion, compared to a 2003 estimate of more than $100 billion.

The Government Accountability Office recently completed a study that concluded

that multiemployer plans face long-term challenges, and we agree with this assessment. Because multiemployer plans are creatures of collective bargaining, the dwindling percentage of union coverage in private-sector employment has halted growth.

In addition, a substantial number of plans are concentrated in industries such as

trucking and retail foods, where employers and unions will encounter increased cost

competition from new competitors.

The PBGC is required by law to review the multiemployer plan insurance program every 5 years to assess, in a report to Congress, whether changes in the current guaranteed benefit can be supported by the existing premium structure. The

PBGC expects to complete work on the next 5-year report in late 2005.

PBGC LIABILITY

Question: In measuring its liability, the PBGC has historically used an interest

rate that is well below market rates. What would the PBGC’s deficit be using the

corporate bond interest rate that Congress enacted last year? And, what would the

PBGC deficit be using the administration’s yield curve methodology?

The administration’s proposals would require some employers to make much larger pension contributions starting right away. How much modeling has the administration done to determine how many companies would not be able to meet those

sudden increases in cash flow demand? How certain are you that we will not see

more bankruptcies as a direct result of this proposal and that you will only be turning some of those ‘‘probables’’ into ‘‘definite problems’’ for the PBGC?

Answer: Actually, the PBGC does use market prices for valuing its liabilities both

on its financial statements and for our claims in bankruptcy. The PBGC conducts

surveys of the prices charged by private-sector insurance companies to write group

annuity contracts and derives an interest factor from those prices that, with PBGC’s

mortality table, will match the prices. The rationale for this approach is that it

maintains a ‘‘level playing field’’ between plans that terminate with PBGC and

plans that terminate in the private sector. Put another way, if a plan sponsor determined to terminate its plan (which would have to be fully funded) and annuitize

the benefits to its employees, a private-sector annuity provider would value those

liabilities the same way that PBGC does.

Using an interest factor based on prices for annuities charged by private-sector

insurance companies, the PBGC’s single-employer deficit was $23.3 billion. If PBGC

had valued liabilities using 100 percent of the spot corporate bond rate that is currently used for determining PBGC premiums, the deficit would have been about $18

billion. (Pursuant to legislation enacted by Congress last year, the corporate bond

rate is used differently for different purposes: (1) a 4-year weighted average is used

to determine plan funding, and (2) a spot rate is used to determine PBGC premiums.) If, instead, the PBGC had valued liabilities using the administration’s yield

curve methodology, the deficit would have been about $19 billion. Both estimates

assume that PBGC would continue to include in liability estimates the present

value of its own future expenses as it does under current procedures. It is also important to note that while the single-employer deficit would be lower using these

approaches, there still would have been a dramatic swing in the corporation’s financial position from a surplus to a very large deficit over the past 3 years.

We have modeled the proposal in the aggregate for the entire defined benefit system. The data indicate that the funded status of both healthy ongoing and at-risk

plans improves over time under the administration’s proposal, which is the core objective of reform. We should not lose sight of the fact that the current funding rules

don’t work and have allowed the huge funding gap to develop and grow. Absent the

kind of fundamental changes in the administration’s proposal, there is a significant

risk that the level of under-funding in terminated plans will get much larger. We

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do not have the information needed to evaluate the financial impact of the proposal

on particular plan sponsors. We believe that the funding rules should apply to all

plan sponsors, and it would be inappropriate to create special rules for a particular

industry or company.

Various underlying business factors apart from pension funding lead to corporate

bankruptcies. That will continue to be the case in the future. If we make no changes

in the funding rules or further relax them, plans of bankrupt firms will be more

under-funded, participants will lose more benefits, and the taxpayer will be put at

greater risk.

It is in everyone’s best interest to keep well-funded plans in the defined benefit

system. At the same time, as we have seen, plan under-funding is destabilizing to

the system. These concerns are fairly and effectively addressed by the administration’s proposal, which would require funding of benefit promises over a reasonable

period of time.

PREPARED STATEMENT OF ANN COMBS

INTRODUCTORY REMARKS

Good afternoon, Chairman Grassley, Ranking Member Baucus, and members of

the committee. Thank you for inviting me to discuss the administration’s proposal

to reform and strengthen the single-employer defined benefit pension system.

The Bush administration believes that the pension promises companies have

made to their workers and retirees must be kept. Single-employer, private-sector defined benefit pension plans cover 16 percent of the Nation’s private workforce, or

about 34 million Americans. The consequences of not honoring pension commitments are unacceptable—the retirement security of millions of current and future

retirees is put at risk.

However, the current system does not ensure that pension plans are adequately

funded. As a result, pension promises are too often broken.

Termination of plans without sufficient assets to pay promised benefits has a very

real human cost. Many workers’ and retirees’ expectations are shattered, and, after

a lifetime of work, they must change their retirement plans to reflect harsh, new

realities. Underfunded plan terminations are also placing an increasing strain on

the pension guaranty system.

Increased claims from terminations of significantly under-funded pension plans

have resulted in a record deficit in the single-employer fund of the PBGC. For the

fiscal year ending September 30, 2004, the PBGC reported a record deficit of $23.3

billion in that fund. The increasing PBGC deficit and high levels of plan under-funding are themselves a cause for concern. More importantly, they are symptomatic of

serious structural problems in the private defined benefit system.

It is important to strengthen the financial health of the defined benefit plan system now. If significantly under-funded pension plans continue to terminate, not only

will some workers lose benefits, but other plan sponsors, including those that are

healthy and have funded their plans in a responsible manner, will be called on to

pay far higher PBGC premiums. Under-funding in the pension system must be corrected now to protect worker benefits and to ensure taxpayers are not put at risk

of being called on to pay for broken promises.

The administration has developed a reform package to improve pension security

for workers and retirees, stabilize the defined benefit system, and avoid a taxpayer

bailout of PBGC. The President’s proposal is based on three main elements.

First, the funding rules must be reformed to ensure that plan sponsors adequately

fund their plans and keep their pension promises. The current system is ineffective

and needlessly complex. The rules fail to ensure that many pension plans are and

remain adequately funded.

Second, disclosure to workers, investors and regulators about pension plan status

must be improved. Workers need to have good information about the funding status

of their pension plans to make informed decisions about their retirement needs and

financial futures. Too often in recent years, participants have mistakenly believed

that their pension plans were well-funded, only to receive a rude shock when the

plan is terminated. Regulators and investors also require more timely and accurate

information about the financial status of pension plans than is provided under current law.

Third, premium rates must be revised to more accurately reflect the risk of a plan

defaulting on its promises and to help restore the PBGC to financial health. The

current premium structure encourages irresponsible behavior by not reflecting a

plan’s true level of risk.

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The proposal would strengthen the funding rules and defined benefit system, so

that the Nation’s workers and retirees can be confident of the secure retirement

they have worked for all their lives. I will now discuss the key provisions for each

element of the President’s proposal and the reasons these provisions are needed to

protect the pensions of the 34 million Americans who are relying on the single-employer defined benefit pension promises made by their employers.

REFORMING THE FUNDING RULES

The funding rules are complicated and ineffective

Current funding rules do not establish accurate funding targets, and the lack of

adequate consequences for under-funding a plan provides insufficient incentive for

plans to become well-funded. In addition, the funding rules fail to take into account

the risk that a plan sponsor will fail.

Weaknesses in the current rules include, for example, multiple and inaccurate

asset and liability measures and discount rates, smoothing mechanisms, credit balances that allow funding holidays to continue even as funding levels deteriorate, excessive discretion over actuarial assumptions, and varying and excessively lengthy

amortization periods. As a result, companies can say they are fully funded when in

fact they are substantially under-funded. Together these weaknesses allow companies to avoid making contributions when they are substantially under-funded. And

in some circumstances, they actually prevent companies that want to increase funding of their pension plans from making additional contributions during good economic times.

These weaknesses contribute to the ability to manipulate funding targets, which

is of particular concern given the fact that they are set too low. There is no uniformity in liability measures under current law. In some cases, employers can stop

making contributions when a plan is funded at 90 percent of ‘‘current liability.’’ But

current liability is not an accurate measure of pension funding requirements; even

100 percent of current liability is often far less than what will be owed if a plan

is terminated. As a result, employers can stop making contributions before a plan

is sufficiently funded to protect participants in the event of termination.

Why is current liability such a poor measure of true pension costs? One reason

is that the interest rate used in determining current liability can be selected from

an interest rate corridor that is based on an average of interest rates over the prior

48 months. As a result, during periods of rapidly changing interest rates, the current liability interest rate may bear little relationship to economic reality and misstate the risks to plan participants. Even if the current liability interest rate reflected current market conditions, it would produce an inaccurate measure of the

plan’s true liability because it is based on a long-term interest rate and fails to take

into account the actual timing of when benefit payments will be due under the plan.

That timing often is considerably sooner, especially for plans with a large number

of older participants near retirement age.

Current liability also fails to account for the risk of plan termination. This is important because terminating plans incur additional costs not reflected in current liability. For example, when plans terminate, participants are more likely to draw

benefits early and elect lump sums. Terminating plans must purchase insurance annuities at prices that reflect market interest rates and administrative expenses.

These factors combine to escalate costs above those reflected in current liability,

often by large amounts. While it is not necessary for all plans to fund to such a

standard, in the case of a plan with a substantial risk of terminating, the pension

funding target should take into account the additional costs of terminating the plan.

Another weakness in the funding rules is their reliance on the so-called ‘‘actuarial

value’’ of plan assets. The actuarial value of plan assets may differ from the fair

market value of plan assets. It may be determined under a formula that ‘‘smooths’’

fluctuations in market value by averaging the value over a number of years. The

use of a smoothed actuarial value of assets distorts the funded status of the plan.

Using fair market value for purposes of the funding rules would give a clearer and

more accurate picture of a plan’s ability to pay promised benefits.

As an example of how all of this can affect workers and retirees, the U.S. Airways

pilots’ plan was 94-percent funded on a current liability basis, but the plan was only

33-percent funded on a termination basis, with a $1.5 billion shortfall. After believing their pensions were substantially secure, U.S. Airways pilots were shocked to

learn how much of their promised benefits would be lost. Bethlehem Steel’s plan

was 84-percent funded on a current liability basis, but the plan turned out to be

only 45-percent funded on a termination basis, with a total shortfall of $4.3 billion.

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The Bush administration’s proposal

The current funding rules must be strengthened to ensure that accrued benefits

are adequately funded. This is particularly important for those plans at the greatest

risk of terminating. The administration’s plan will bring simplicity, accuracy, stability, and flexibility to the funding rules, encouraging employers to fully fund their

plans and ensuring that benefit promises are kept.

Under the President’s proposal, the multiple sets of funding rules applicable to

single-employer defined benefit plans would be replaced with a single set of rules.

The rules would provide, for each plan, a single funding target that is based on

meaningful, accurate measures of its liabilities that reflect the financial health of

the employer and use fair market values of assets. Funding shortfalls would be amortized and paid over 7 years. Plan sponsors would have the opportunity to make

additional, tax-deductible contributions in good years, even when the plan’s assets

are substantially above its funding target. In addition to the changes to the funding

rules, new limits would be placed on unfunded benefit promises, reporting and disclosure of funding information would be improved, and PBGC premiums would be

reformed to more fully reflect the risks and costs to the insurance program.

Funding targets will depend on the plan sponsor’s financial health

Pension liability computations should reflect the true present value of accrued future benefits—this is a key component of accuracy. Workers and retirees are interested in the present value of liabilities so that they can determine whether their

plans and promised benefits are adequately funded. Plan sponsors and investors are

interested in the present value of liabilities in order to determine the demands pension liabilities will place on the company’s cash flows.

The administration’s proposal provides a single conceptual measure of liabilities

based on benefits earned to date. Assumptions are modified as needed to reflect the

financial health of the plan sponsor and the risk of termination posed by the plan.

A plan’s funding target would be the plan’s ongoing, or alternatively, its at-risk liability, depending on the sponsor’s financial health.

For a plan sponsor that is healthy, the funding target would be the plan’s ongoing

liability. The plan sponsor is considered financially healthy if any member of the

plan sponsor’s control group has senior unsecured debt rated as being investment

grade (Baa or better). If a plan sponsor is financially weak, the funding target generally would be the plan’s at-risk liability. A plan sponsor is considered financially

weak if its senior unsecured debt is rated as below investment grade by every rating

agency that rates the sponsor. A plan’s funding target would phase up from ongoing

to at-risk over a 5-year period. Conversely, if a plan’s credit rating is upgraded to

investment grade, its funding target would immediately drop to ongoing liability.

Credit ratings are used to measure financial health because empirical evidence

shows that a company’s time spent in below investment grade status is a strong indicator of the likelihood of plan termination. It is also critical that a market-based

test be used to establish financial health.

A plan’s ongoing liability is equal to the present value of all benefits that the plan

is expected to pay in the future, based on benefits earned through the beginning

of the plan year. Workers are assumed to retire and to choose lump sums as others

have in the past. A plan’s at-risk liability is based on the same benefits, but assumes that employees will take lump sums and retire as soon as they can, and includes an additional amount reflective of the transaction cost of winding up a plan.

These assumptions are designed to reflect behavior that typically occurs prior to

plan termination when the financial health of the employer deteriorates.

The applicable funding target is calculated by discounting benefit liabilities based

on a yield curve of long-term corporate bonds. The discount rate would reflect the

duration of the liabilities. A plan’s actuary would project the plan’s cash flow in each

future year and discount payments using the appropriate interest rate for the payment. In general, with a typical yield curve, plans with older workforces where payments are due sooner will discount a greater proportion of their liabilities with the

lower interest rates from the short-end of the yield curve than plans with younger

workforces where larger cash payments are delayed into the future. The corporate

bond yield curve would be published by the Secretary of Treasury and would be

based on the interest rates, averaged over 90 business days, for high quality corporate bonds rated AA, with varying maturities.

The use of a single conceptual measure of liabilities will simplify the funding

rules. It will tell plan sponsors, investors, regulators, and most importantly, workers

and retirees, whether a plan is adequately funded.

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Funding shortfalls should be made up over a reasonable period

Another problem with the current funding rules is that under-funded plans are

permitted to make up their shortfalls over too long a period of time. In addition,

under-funded plans are permitted funding holidays. These rules put workers at risk

of having their plans terminate without adequate funding.

Under current law, if the unfunded accrued liability is attributable to a plan

amendment, the amortization period for making up the shortfall is 30 years. Experience shows this is too long. There is too much risk that the plan will be terminated

before 30 years has passed. Furthermore, collectively bargained plans often have a

series of benefit increases every few years, which has the effect of increasing all of

the liabilities accrued prior to the benefit increase as well as increasing future liabilities. As a result, these plans are perennially under-funded.

The credit balance rules for plan funding under current law also contribute to

plan under-funding. The credit balance rules allow an employer to apply their contributions in excess of minimum requirements from an earlier year as an offset to

the minimum funding requirement for a subsequent year without restrictions. This

loophole allows a plan to have a contribution holiday without regard to whether the

additional contributions have earned the assumed rate of interest or have instead

lost money in a down market—and, more importantly, regardless of the current

funded status of the plan. Credit balance rules harm the retirement security of

workers and retirees. In the Bethlehem Steel and the U.S. Airways pilots’ plan termination cases, for example, no contributions were made (or required to be made,

as a result of credit balances) to either plan during the 3 or 4 years leading up to

plan termination.

Under the administration’s proposal, plans would annually contribute enough to

address their funding shortfall over a reasonable period of time, without funding

holidays, until the shortfall is eliminated. Plan funding shortfalls would be amortized over a 7-year period. The current-law provision allowing an extension of amortization periods would no longer be available.

Opportunity to increase funding in good years

We also must address the overly prescriptive funding rules for well-funded plans

that discourage companies from building up a cushion to minimize contributions in

lean years. To keep healthy companies in the defined benefit system, we need to

give them better incentives.

The current funding rules can place a pension plan sponsor in the position of

being unable to make deductible contributions in one year and then being subject

to accelerated deficit reduction contributions in a subsequent year. This problem is

caused by the interaction of the minimum funding requirements and the rules governing maximum deductible contributions. The rules restrict employers’ ability to

build up a cushion that could minimize the risk that contributions will have to be

severely increased in poor economic times. This volatility in required contributions

makes it difficult for plan sponsors to predict their funding obligations, and makes

it difficult to prevent large required contributions during economic downturns when

the company is least able to pay.

The administration’s proposal would permit plan sponsors to make additional deductible contributions up to a new higher maximum deductible amount. This would

permit companies to increase funding during good economic times. Funding would

be permitted on a tax-deductible basis to the extent the plan’s assets on the valuation date are less than the sum of the plan’s funding target for the plan year, the

applicable normal cost and a specified cushion. The cushion amount would enable

plan sponsors to protect against funding volatility, and would be equal to 30 percent

of the plan’s funding target plus an amount to pre-fund projected salary increases

(or projected benefit increases in a flat-dollar plan). Plans would always be permitted to fund up to their at-risk liability target.

This cushion will help provide workers and retirees greater retirement security

by increasing the assets available to finance retirement benefits.

Limitations on plans funded below target levels

The current rules encourage some plans to be chronically under-funded, in part,

because they shift potential losses to third parties. This is what economists refer

to as a ‘‘moral hazard.’’ Under current law, sponsors of under-funded plans can continue to provide for additional accruals and, in some situations, even make new benefit promises, while pushing the cost of paying for those benefits off into the future.

For this reason, some companies have an incentive to provide generous pension benefits that they cannot currently finance, rather than increase wages. The company,

its workers and any union officials representing them know that at least some of

the additional benefits will be paid, if not by their own plan, then by other plan

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sponsors in the form of PBGC guarantees. Under our proposed funding rules, financially strong companies, in contrast, have little incentive to make unrealistic benefit

promises because they know that they fund them in a reasonably timely manner.

If a company’s plan is poorly funded, the company should be precluded from

adopting further benefit increases unless it fully funds them, especially if it is in

a weak financial position. If a plan is severely under-funded, retiring employees

should not be able to elect lump sums and similar accelerated benefits. The payment

of those benefits allows those participants to receive the full value of their benefits

while depleting the plan assets for the remaining participants. A similar concern applies when a severely under-funded plan purchases annuities.

The administration believes that we must ensure that companies, especially those

in difficult financial straits, make only benefit promises they can afford, and take

steps to fulfill their promises already made by appropriately funding their pension

plans. In order to accomplish this goal, the proposal would place additional meaningful limitations on plans that are funded substantially below target levels.

First, the rules would limit benefit increases for certain under-funded plans. For

a plan where the market value of the plan’s assets is less than or equal to 80 percent of the funding target, no amendment increasing benefits would be permitted.

If the market value of the plan’s assets is above 80 percent of the funding target,

but was less than 100 percent for the prior plan year, then no benefit increase

amendment that would cause the market value of the plan’s assets to be less than

80 percent of the funding target would be permitted. In either case, the sponsor

could avoid the application of these limits by choosing to contribute the minimum

required contribution and the increase in the funding target attributable to an

amendment increasing benefits.

Second, the rules would limit lump-sum distributions or other accelerated benefit

distributions for certain under-funded plans. Limits would apply if either the market value of a plan’s assets is less than or equal to 60 percent of the funding target

or the plan sponsor is financially weak and the market value of the plan’s assets

is less than or equal to 80 percent of the funding target.

Third, the rules would limit accruals for plans with severe funding shortfalls or

sponsors in bankruptcy with assets less than the funding target. A plan is considered severely under-funded if the plan sponsor is financially weak and the market

value of the plan’s assets is less than or equal to 60 percent of the funding target.

These plans pose great risk of plan termination and would effectively be required

to be frozen.

Lastly, the rules would address an abuse recently seen in the airline industry—

where executives of companies in financial difficulty have their nonqualified deferred compensation arrangements funded and made more secure, without addressing the risk to the retirement income of rank and file employees caused by severely

under-funded pension plans. The rules would prohibit funding such executive compensation arrangements if a financially weak plan sponsor has a severely underfunded plan. Also, the rules would prohibit funding executive compensation arrangements less than 6 months before or 6 months after the termination of a plan where

the plan assets are not sufficient to provide all benefits due under the plan. A plan

would have a right of action under ERISA against any top executive whose nonqualified deferred compensation arrangement was funded during the period of the

prohibition to recover the amount that was funded.

Plans that become subject to any of these benefit limitations would be required

under ERISA to furnish a related notice to affected workers and retirees. In addition to letting workers know that limits have kicked in, this notice will alert workers when funding levels deteriorate and benefits already earned are in jeopardy.

IMPROVING DISCLOSURE TO WORKERS, INVESTORS, AND REGULATORS

The financial health of defined benefit plans must be transparent and fully disclosed to the workers and their families who rely on promised benefits for a secure

and dignified retirement. Investors and other stakeholders also need this information because the funded status of a pension plan affects a company’s earnings and

creditworthiness.

While ERISA includes a number of reporting and disclosure requirements that

provide workers with information about their employee benefits, the timeliness and

usefulness of that information must be improved.

For example, the principal Federal source of information about private-sector defined benefit plans is the Form 5500. Schedule B, the actuarial statement filed with

the Form 5500, reports information on the plan’s assets, liabilities and compliance

with funding requirements. Because ERISA provides for a significant lapse of time

between the end of a plan year and the time when the Form 5500 must be filed,

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regulatory agencies are not notified of the plan’s funded status for almost 2 years

after the actual valuation date. If the market value of a plan’s assets is less than

its funding target, the relevant regulatory agencies need to monitor whether the

plan is complying with the funding requirements on a more current basis.

The PBGC does receive more timely information regarding a limited number of

under-funded plans that pose the greatest threat to the system under Section 4010

of ERISA. Section 4010 data provides identification, financial, and actuarial information about the plan. The financial information must include the company’s audited financial statement. Sponsors also are required to provide actuarial information that includes the market value of their pension plan’s assets, the value of the

benefit liabilities on a termination basis, and a summary of the plan provisions for

eligibility and benefits.

However, current law prohibits disclosure, so this information may not be made

publicly available. This makes no sense. Basic data regarding the funded status of

a pension plan is vitally important to participants and investors. Making information regarding the financial condition of the pension plan publicly available would

benefit investors and other stakeholders and is consistent with Federal securities

laws that Congress has strengthened to require the disclosure of information material to the financial condition of a publicly-traded company.

The most fundamental disclosure requirement of a pension’s funding status to

workers under current law is the summary annual report (SAR). The SAR discloses

certain basic financial information from the Form 5500 including the pension plan’s

net asset value, expenses, income, contributions, and gains or losses. Pension plans

are required to furnish a SAR to all covered workers and retirees within 2 months

following the filing deadline of the Form 5500.

Information on a plan’s funding target and a comparison of that liability to the

market value of assets would provide more accurate disclosure of a plan’s funded

status. Providing information on a more timely basis would further improve the usefulness of this information for workers and retirees.

The Bush administration’s proposal

The administration’s proposal would allow information filed with the PBGC to be

disclosable to the public and would provide for more timely and accurate disclosure

of information to workers and retirees.

Provide broader dissemination of plan information

Under the administration’s proposal, the Section 4010 information filed with the

PBGC would be made public, except for the information subject to Freedom of Information Act protections for corporate financial information, which includes confidential ‘‘trade secrets and commercial or financial information.’’

Broadening the dissemination of information on pension plans with unfunded liabilities, currently restricted to the PBGC, is critical to workers, financial markets

and the public at large. Disclosing this information will both improve market efficiency and help encourage employers to appropriately fund their plans.

Provide more meaningful and timely information

The President’s proposal would change the information required to be disclosed

on the Form 5500 and SAR. Plans would be required to disclose the plan’s ongoing

liability and at-risk liability in the Form 5500, whether or not the plan sponsor is

financially weak. The Schedule B actuarial statement would show the market value

of the plan’s assets, its ongoing liability and its at-risk liability.

The information provided to workers and retirees in the SAR would be more

meaningful and timely. It would include a presentation of the funding status of the

plan for each of the last 3 years. The funding status would be shown as a percentage based on the ratio of the plan’s assets to its funding target. In addition, the SAR

would include information on the company’s financial health and on the PBGC guarantee. The due date for furnishing the SAR for all plans would be accelerated to

15 days after the filing date for the Form 5500.

The proposal also would provide for more timely disclosure of Schedule B information for plans that cover more than 100 participants and that are subject to the requirement to make quarterly contributions for a plan year (i.e., a plan that had assets less than the funding target as of the prior valuation date). The deadline for

the Schedule B report of the actuarial statement would be shortened for those plans

to the 15th day of the second month following the close of the plan year, or February

15 for a calendar year plan. If any contribution is subsequently made for the plan

year, the additional contribution would be reflected in an amended Schedule B that

would be filed with the Form 5500.

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REFORMING PREMIUMS TO BETTER REFLECT PLAN RISK AND RESTORING

THE PBGC TO FINANCIAL HEALTH

There are two fundamental problems with PBGC premiums. First, the premium

structure does not meet basic insurance principles, including those that govern private-sector insurance plans. Second, the premiums do not raise sufficient revenue

to meet expected claims. The single-employer program lacks risk-based underwriting standards. Plan sponsors face limited accountability regardless of the risk

they impose on the system. As a result, there has been a tremendous amount of

cost-shifting from financially troubled companies with under-funded plans to

healthy companies with well-funded plans.

This excessive subsidization extends across industry sectors—to date, the steel

and airline industries have accounted for more than 70 percent of PBGC’s claims

by dollar amount while covering less than 5 percent of the insured base.

The PBGC also needs better tools to carry out its statutory responsibilities in an

effective way and to protect its ability to pay benefits by shielding itself from unreasonable costs. Recent events have demonstrated that the agency’s ability to protect

the interests of beneficiaries and premium payers is extremely limited. This is especially true when a plan sponsor enters bankruptcy or provides plant shutdown benefits—benefits triggered by a plant closing or other condition that are generally not

funded until the event occurs. Currently, the agency has few tools at its disposal

other than to move to terminate plans in order to protect the program against further losses.

The Bush administration’s proposal

The administration’s proposal would reform the PBGC’s premium structure. The

flat per-participant premium will be immediately adjusted to $30 initially to reflect

the growth in worker wages since 1991, when the current $19 figure was set in law.

This recognizes the fact that the benefit guarantee continued to grow with wages

during this period, even as the premium was frozen. Going forward, the flat-rate

premium will be indexed for wage growth.

In addition to the flat-rate premium, a risk-based premium will be charged based

on the gap between a plan’s funding target and its assets. Because the funding target takes account of the sponsor’s financial condition, tying the risk-based premium

to the funding shortfall effectively adjusts the premium for both the degree of

under-funding and the risk of termination. All under-funded plans would pay the

risk-based premium. The PBGC board—which consists of the Secretaries of Labor,

Treasury and Commerce—would be given the ability to adjust the risk-based premium rate periodically so that premium revenue is sufficient to cover expected

losses and improve PBGC’s financial condition. Charging under-funded plans more

gives employers an additional incentive to fully fund their pension promises.

As part of improving PBGC’s financial condition, additional reforms are needed.

Plan sponsor bankruptcies and plant-shutdown benefits increase the probability of

plan terminations and impose unreasonable costs on the PBGC. The proposal would

freeze the PBGC guarantee limit when a company enters bankruptcy and allow the

perfection of liens during bankruptcy by the PBGC for missed required pension contributions. The proposal also would prospectively eliminate the guarantee of certain

unfunded contingent liability benefits, such as shutdown benefits, and prohibit such

benefits under pension plans.

CONCLUSION

The Bush administration is committed to working with Congress to ensure that

the defined benefit pension reforms included with the President’s budget—strengthening the funding rules, improving disclosure, and reforming premiums—are enacted into law.

As I noted earlier, the primary goals of the administration’s proposal are to improve pension security for workers and retirees, to stabilize the defined benefit pension system, and to avoid a taxpayer bailout of the PBGC. This can be achieved by

strengthening the financial integrity of the single-employer defined benefit system

and making sure that pension promises made are promises kept. We look forward

to working with members of this committee to achieve greater retirement security

for the millions of Americans who depend on defined benefit plans.

RESPONSES TO QUESTIONS FROM SENATOR ROCKEFELLER

Question: I am very concerned with some of the administration’s suggestions for

limiting benefit increases and accruals. It seems to me that these changes would

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punish workers in cases where company management fails to invest enough money

in the pension plan.

The administration has claimed that these benefit restrictions would prompt

workers to put pressure on employers to better fund pension plans. However, it is

not clear to me how workers could effectively stop employers from under-funding

plans.

I would like to hear how you expect workers to protect themselves, and please

specifically address how they could do so between contract negotiations as their benefits are being cut.

I would also like to know what would prevent an employer from purposely underfunding the pension plan in order to deprive workers of hard-won pension benefit

increases?

Answer: The administration believes that we must ensure that companies make

only benefit promises they can afford, and keep the promises already made by appropriately funding their pension plans. When companies are unable to keep their

pension promises, the losses are shifted to the pension insurance system and to

workers. It is these empty promises that harm workers by putting their retirement

security at risk. The new stronger minimum funding rules combined with the proposed limitations will prevent companies from making hollow promises.

The stronger minimum funding rules will prevent employers from purposely

under-funding their pension plans. Companies will be required to fund their plans

up to a meaningful funding target. Companies that fall below the minimum funding

target will be required to fund up to the target within a reasonable period of time.

A plan sponsor that is operating outside of bankruptcy cannot ignore its funding obligations without serious consequences. There are significant enforcement measures

available to the IRS and the PBGC to prevent firms from ignoring funding obligations.

The proposed benefit limitations will apply only when a plan’s funded status falls

below acceptable levels. The limit on benefit increases for certain under-funded

plans will prevent companies from promising additional benefits unless promises already made to workers are adequately funded. The limit on accruals will apply only

for plans with severe funding shortfalls or sponsors in bankruptcy with under-funded plans. The limitations will not affect benefits already earned. Rather than deprive workers of hard-won pension benefit increases, we believe that these proposals

create a strong incentive for employers to adequately fund their plans—making it

more likely that workers’ retirement expectations will be met. Our proposal takes

into account existing collective bargaining agreements by not applying these benefit

limitations until the earlier of the end of the contract term or 2009.

Plans that become subject to any of the benefit limitations will be required to notify affected workers, making them aware that deteriorating funding is threatening

their benefits. Workers need this information so that they can have realistic expectations about their company’s ability to fund pension promises. We also believe that

in some instances, companies will improve the funding of their plans in order to

avoid notifying workers and thereby creating worker dissatisfaction.

Question: I am very concerned that the administration has made no proposal to

address the pension crisis in the airline industry. A considerable amount of the deficit facing the PBGC is expected to derive from failing airline pension plans. Yet

the administration has proposed no remedies specific to that industry that would

help airlines maintain their plans.

Some airlines have asked Congress to consider relief that would allow them to essentially restructure their pension plans. By giving the companies a longer time period to pay off debt and perhaps limiting the PBGC’s exposure to increases in pension liabilities, airlines may be able to save their pension plans.

What industry-specific relief is the administration willing to consider to protect

the pension benefits of airline employees and help the companies maintain promises

they made to their workers?

Answer: We understand the financial difficulties the airlines are facing. Congress

and the administration have provided assistance to the airlines in the form of

grants, loan guarantees, and short-term funding relief when such assistance was determined to be appropriate.

The administration’s pension reform proposal would strengthen the funding rules

to improve the health of the entire defined benefit pension system. This is particularly important for those under-funded plans that pose the greatest risk of terminating. Neither the defined benefit system nor the pension insurance system is designed to provide or capable of providing targeted relief to specific industries. It is

designed to insure benefits for participants in plans that fail.

Relaxing the funding rules for a specific industry would set a dangerous precedent

for the pension insurance program. We do not believe that the interests of particiVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00071 Fmt 6601 Sfmt 6621 23367.000 SFINANC2 PsN: SFINANC2
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* Cooper v. IBM Personal Pension Plan, 274 F. Supp. 2d 1010 (S.D. Ill. 2003) (holding that

cash balance plans violate age discrimination provisions of ERISA). Other courts, however, have

pants, other premium payers, or the taxpayer are best served by allowing companies

to effectively borrow from their employees and the insurance fund to meet their financial obligations.

I would also emphasize that the majority of losses incurred by the PBGC to date

have been in industries other than airlines and that the majority of the insurance

fund exposure to ‘‘reasonably possible’’ claims is in other industry sectors. So, the

financial pressures on the pension insurance program are not unique to the airline

industry.

Current law allows plan sponsors to obtain funding waivers if they are experiencing temporary substantial business hardship. The IRS can, in consultation with

the PBGC, and often does, impose conditions on obtaining a waiver that protect the

interests of participants and the pension insurance program.

Question: I appreciate the difficulty we are facing in trying to shore up the defined

benefit pension plan system. On the one hand, we want to better protect workers

by making sure that employers are adequately funding their pension promises. On

the other hand, we want to encourage employers to continue to provide defined benefit pensions that protect workers and retirees from the risks associated with the

stock market.

I am very concerned that the administration’s proposal focuses just on addressing

the deficit faced by the PBGC. Many aspects of this proposal would increase funding

to the PBGC, but actually make it much harder for employers to maintain these

plans.

For example, the yield curve proposed by the administration would be much more

volatile and difficult for employers to predict and plan for. The yield curve also substantially increases the liability calculations for industries that have older workers.

Even healthy plans would see substantial premium increases under the administration’s reforms.

I am concerned that these are shortsighted fixes to the PBGC’s funding problems.

As defined benefit plans become more and more expensive for employers, many companies will simply shift away from offering such pensions. As healthy plans voluntarily terminate, the funding problems in the system increase, creating a vicious

cycle.

How does the administration propose to encourage companies to continue to offer

defined benefit plans?

Answer: We would respectfully disagree that the administration’s proposal focuses

just on improving the pension insurance program deficit or that it would or should

cause employers to abandon their pension plans. We believe the proposal appropriately balances competing considerations. The objective is to ensure that plan

sponsors honor the promises they have made, and the proposal requires companies

to make up their funding gap over a reasonable period of time. At the same time,

the administration’s proposal provides additional flexibility for plan sponsors and

provides numerous incentives for them to maintain and prudently fund the plans

they sponsor.

For example, companies will be able to make much larger tax-deductible contributions to their plans during good economic times than under current law. Companies

that contribute more than the minimum requirement would effectively shorten the

amortization period. They would be able to reduce the amount of risk-based premium that would have to be paid. And companies would likely benefit from improved credit ratings if they reduced their unfunded pension liability, thus lowering

their cost of capital.

We also do not agree that the administration’s proposal would lead to greater volatility and make it more difficult for companies to predict their funding requirements. The risk and volatility in the pension plan is a function of the business decisions made by the company. Current law simply masks that volatility and allows

companies to shift the risks to third parties. It is because of current-law features

like smoothing and credit balances that plans sometimes are so under-funded when

they terminate. Hiding the problem doesn’t make it go away. There are numerous

ways under the administration’s proposal in which companies can minimize risk and

volatility and make funding more predictable.

The administration also believes that Congress should act promptly to clarify the

legal status of cash balance and other hybrid pension plans. The only new defined

benefit plans created in recent years have been alternative benefit structures, such

as cash balance or pension equity plans that are designed to meet the needs of a

younger, more mobile workforce. Unfortunately, as a result of a single Federal court

decision, the legal status of these types of plans is in question.*

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disagreed. Tootle v. ARINC, Inc., 222 F.R.D. 88 (D. Md. 2004); Eaton v. Orion Corp., 117 F.

Supp. 2d 812 (S.D. Ind. 2000).

RESPONSES TO QUESTIONS FROM SENATOR SMITH

PAYOUT OPTIONS

Question: So many of the demographic figures I have seen lately speak to the fact

that more and more of the responsibility for accumulating retirement savings is

shifting to the individual. Half of American workers get help from their employers

in the form of employer-provided savings, and half of our workers must do it on

their own. Of course we’re here discussing some of the ways to achieve further security for those who do have such access to traditional pensions and what can be done

to make them more secure.

I have actually introduced legislation that would give the same guaranteed payout

streams as traditional pensions to those who do not have access to such employerprovided plans. What the legislation provides is an incentive to consider the ‘‘delayed gratification’’ of an annuitized payout you can’t outlive when compared

against the ‘‘instant gratification’’ of receiving a simple lump sum.

The reason why I raise this issue is that even the defined benefit pension plans

we are discussing today are trending increasingly toward paying lump sums at retirement; in particular, cash balance plans. For those of us concerned that retirees

need to consider taking a guaranteed payout stream rather than just a lump sum,

what can you tell me about your plans that will create some payout options for retirees?

Answer: The administration’s funding proposal will strengthen and preserve the

defined benefit system. Preserving the system will enable more workers to have the

option of taking their pension distributions in the form of annuities. The administration’s proposal also eliminates an inappropriate incentive for participants to take

lump-sum distributions.

Under current law, the use of an inappropriately low discount rate for determining the value of lump sums creates an incentive for participants to choose lump

sums. Under our proposal, the yield curve would be used to calculate minimum

lump sums, which will eliminate this distortion that can bias a participant’s payout

decision toward lump sums. This reform includes a transition period, so that employees who are expecting to retire in the near future are not subject to an abrupt

change in the amount of their lump sums as a result of changes in law. The new

basis would not apply to distributions in 2005 and 2006 and would be phased in

for distributions in 2007 and 2008, with full implementation beginning only in 2009.

MULTIEMPLOYER PLANS

Question: It is my understanding that the administration is not planning on taking any action on multiemployer plans in the near future. However, there is a crisis

brewing among the multiemployer plans as well. Some very large plans are close

to having to go into ‘‘reorganization,’’ and many retirees in my State of Oregon will

be impacted. Does the administration plan on reporting to us on the risk that the

multiemployer system would have to assume if some of these multiemployer plans

become insolvent?

Answer: The administration recognizes that changes in the multiemployer funding

rules are necessary. However, we focused on single-employer plans first because the

problems facing single-employer plans are more immediate and acute. Also, due to

the unique nature of multiemployer plans, not all elements of the single-employer

proposal could be immediately applied to multiemployer plans. We believe it is vitally important that Congress enact legislation to protect the retirement security of

workers in these single-employer pension plans. At the same time, however, we

must remember that there are millions of Americans who are covered by multiemployer pension plans, and that their retirement security is equally important. We

should work together in a bipartisan fashion to ensure that multiemployer plans are

strengthened.

The multiemployer insurance program covers about 9.8 million workers and retirees in about 1,600 plans. The program has only one source of funds, an annual premium payment of $2.60 per participant that generates about $24 million of income

per year.

The PBGC insurance comes into play when a multiemployer plan becomes insolvent—that is, when the plan does not have enough assets to pay benefits that fall

under the statutory limit, which was originally set at less than $6,600 per year for

a retiree with 30 years of service. In 2001, Congress amended the law to double the

limit—to $12,870 per year—but did not increase the premium. Between 1980 and

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2000, relatively few multiemployer plans failed; the agency paid out $167 million

to some 33 plans.

Recently, however, more plans have failed. In its 2004 Annual Report, PBGC estimates that financial assistance payments to multiemployer plans denoted as

‘‘probables’’ will reach $30 million in 2005, $90 million in 2006, and $100 million

per year for at least a decade thereafter. In addition, it is ‘‘reasonably possible’’ that

other multiemployer plans will require future financial assistance in the amount of

$108 million in present-value terms.

The multiemployer program ran surpluses for over 20 years until it recorded its

first deficit of $261 million in FY 2003. The multiemployer program reported a deficit of $236 million in FY 2004. This is in contrast to the $23.3-billion deficit in the

single-employer program.

In the 2004 Annual Report, PBGC estimated that, as of September 30, 2004, the

total under-funding in insured multiemployer plans is more than $150 billion, compared to a 2003 estimate of more than $100 billion.

The Government Accountability Office recently completed a study that concluded

that multiemployer plans face long-term challenges, and we agree with this assessment. Because multiemployer plans are creatures of collective bargaining, the dwindling percentage of union coverage in private-sector employment has halted growth.

In addition, a substantial number of plans are concentrated in industries such as

trucking and retail foods, where employers and unions will encounter increased cost

competition from new competitors.

The PBGC is required by law to review the multiemployer plan insurance program every 5 years to assess, in a report to Congress, whether changes in the current guaranteed benefit can be supported by the existing premium structure. The

PBGC expects to complete work on the next 5-year report in late 2005.

PBGC LIABILITY

Question: In measuring its liability, the PBGC has historically used an interest

rate that is well below market rates. What would the PBGC’s deficit be using the

corporate bond interest rate that Congress enacted last year? And, what would the

PBGC deficit be using the administration’s yield curve methodology?

The administration’s proposals would require some employers to make much larger pension contributions starting right away. How much modeling has the administration done to determine how many companies would not be able to meet those

sudden increases in cash flow demand? How certain are you that we will not see

more bankruptcies as a direct result of this proposal and that you will only be turning some of those ‘‘probables’’ into ‘‘definite problems’’ for the PBGC?

Answer: Actually, the PBGC does use market prices for valuing its liabilities both

on its financial statements and for our claims in bankruptcy. The PBGC conducts

surveys of the prices charged by private-sector insurance companies to write group

annuity contracts and derives an interest factor from those prices that, with PBGC’s

mortality table, will match the prices. The rationale for this approach is that it

maintains a ‘‘level playing field’’ between plans that terminate with PBGC and

plans that terminate in the private sector. Put another way, if a plan sponsor determined to terminate its plan (which would have to be fully funded) and annuitize

the benefits to its employees, a private-sector annuity provider would value those

liabilities the same way that PBGC does.

Using an interest factor based on prices for annuities charged by private-sector

insurance companies, the PBGC’s single-employer deficit was $23.3 billion. If PBGC

had valued liabilities using 100 percent of the spot corporate bond rate that is currently used for determining PBGC premiums, the deficit would have been about $18

billion. (Pursuant to legislation enacted by Congress last year, the corporate bond

rate is used differently for different purposes: (1) a 4-year weighted average is used

to determine plan funding, and (2) a spot rate is used to determine PBGC premiums.) If, instead, the PBGC had valued liabilities using the administration’s yield

curve methodology, the deficit would have been about $19 billion. Both estimates

assume that PBGC would continue to include in liability estimates the present

value of its own future expenses as it does under current procedures. It is also important to note that while the single-employer deficit would be lower using these

approaches, there still would have been a dramatic swing in the corporation’s financial position from a surplus to a very large deficit over the past 3 years.

We have modeled the proposal in the aggregate for the entire defined benefit system. The data indicate that the funded status of both healthy ongoing and at-risk

plans improves over time under the administration’s proposal, which is the core objective of reform. We should not lose sight of the fact that the current funding rules

don’t work and have allowed the huge funding gap to develop and grow. Absent the

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kind of fundamental changes in the administration’s proposal, there is a significant

risk that the level of under-funding in terminated plans will get much larger. We

do not have the information needed to evaluate the financial impact of the proposal

on particular plan sponsors. We believe that the funding rules should apply to all

plan sponsors, and it would be inappropriate to create special rules for a particular

industry or company.

Various underlying business factors apart from pension funding lead to corporate

bankruptcies. That will continue to be the case in the future. If we make no changes

in the funding rules or further relax them, plans of bankrupt firms will be more

under-funded, participants will lose more benefits, and the taxpayer will be put at

greater risk.

It is in everyone’s best interest to keep well-funded plans in the defined benefit

system. At the same time, as we have seen, plan under-funding is destabilizing to

the system. These concerns are fairly and effectively addressed by the administration’s proposal, which would require funding of benefit promises over a reasonable

period of time.

PREPARED STATEMENT OF HON. CHARLES GRASSLEY

Today, the Finance Committee will hear testimony on the state of defined benefit

pension plans. We will focus on the government backer of that system, the Pension

Benefit Guaranty Corporation, or ‘‘PBGC,’’ and the administration’s recent proposal

to strengthen pension funding. Defined benefit plans are a critical part of our Nation’s pension system and our economy as a whole. These plans provide retirement

income to millions of Americans. Millions of current workers count on these benefits

as they look forward to retirement. Today, our defined benefit pension system is

clouded with uncertainty. There is uncertainty for plan sponsors regarding the interest rate used to calculate their pension liabilities. And there is uncertainty for

participants who read the headlines and wonder if their pension benefits will really

be there for them when they retire.

In the last Congress, attention began to focus on replacing the 30-year Treasury

rate for pension funding purposes with a new rate. At the same time, questions

began to be raised whether we needed to take a more comprehensive look at reforming the pension funding rules. Here in the Finance Committee, we worked in the

bipartisan tradition of this committee on the NESTEG bill. NESTEG included a permanent replacement for the 30-year Treasury rate with the yield curve along with

a first round of proposals from the administration to strengthen pension funding.

In acting on NESTEG, I along with Senator Baucus also asked the administration

to provide details on the more comprehensive pension funding reforms on which

they were working.

We now have those details, and will spend a considerable amount of time here

today discussing and debating them. I look forward to a spirited and thought-provoking discussion. I believe it is critically important that we enact a permanent set

of pension funding rules this year. It is critically important for our economy. It is

critically important for the companies that sponsor these plans. Most of all, it is

critically important for the workers who depend on these plans for their retirement.

To that end, Senator Baucus and I have re-introduced last year’s committee-reported NESTEG bill, and announced our intention to work to reform the pension

funding rules in a permanent manner. Defined benefit plans are a vital part of our

private retirement system. At the same time that we recognize the defined benefit

pension system’s many good attributes, however, we must be mindful of its current

problems.

The PBGC’s current deficit is $23 billion. That’s $23 billion of exposure for all taxpayers. Most of those taxpayers do not have a stake in the defined benefit system.

Only about 20 percent of workers have a defined benefit plan today. About half of

workers lack an employer-provided retirement plan—either defined benefit or defined contribution—altogether. That’s a sad and disturbing statement in itself.

Hopefully, we can move that percentage up a lot. To the extent that progress has

been made on increasing retirement plan coverage, this committee has been largely

responsible. I worked to have retirement savings provisions included in the 2001 tax

cut. And I’ve enjoyed a long relationship working with Senator Baucus on increasing

coverage and improving our retirement system. One such idea is the bipartisan savers’ credit that my friend, Senator Baucus, pursued with others in the 2001 tax act.

Since only about 20 percent of workers participate in the defined benefit system,

one question we have to confront is whether the other 80 percent of workers not

covered by a defined benefit plan should be responsible for subsidizing the pension

benefits of the minority who do. There are other alarming trends to note as well.

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Many employers, particularly those in older industries, have over-promised or

under-funded, and often both. Those promises are now coming due. Too often, these

businesses, with the collaboration of unions, act as if their obligations to their workers are the taxpayers’ responsibility.

Far too often, large companies have cavalierly sloughed off their defined benefit

liability onto the taxpayers. Far, far too often the taxpayers have ended up holding

the bag on a badly-negotiated employee benefit deal. The administration, to its credit, has stepped up with a tough defined benefit reform package that would strengthen pension funding. The predictable howling from some employers and union groups

has begun. I’d say to the howlers, we’re, as Ross Perot used to say, ‘‘all ears.’’ But,

what we don’t want to hear is complaints only. If you don’t like the administration’s

tough medicine, what’s your solution? How do you assure the taxpayers that we’re

not digging a bigger deficit ditch at the PBGC? How do you assure current retirees

that they can count on a funding source for the benefits that were promised to

them? How do you assure current workers that their promised defined benefits

won’t be defined and paid by the Federal Government? I’m looking for answers here.

I’m not looking for complaints without constructive alternatives.

While we’re talking about constructive alternatives, I’d like everyone in Congress

to consider turning off the anti-Social Security reform water cannon for an afternoon. Let’s put away the attack charts, shut down the gimmicky biased benefit calculators, focus on solving a problem, and do the people’s business. Instead of strident statements against any effort to reform Social Security, I’d like us to recognize

that President Bush has raised the profile of our Nation’s retirement security challenges. He has used the bully pulpit to put retirement security issues front and center. Let’s not waste the opportunity. I’m still hopeful that the Finance Committee

can rise above the discussions taking place over the air waves on Social Security

and work toward a long-term solvency proposal. Perhaps fixing the defined benefit

plan system can be part of that effort. We owe it to the people who sent us here

to focus on these problems. Most of us got on this committee to solve problems, and

we’re going to do that.

PREPARED STATEMENT OF RANDALL S. KROSZNER

Good afternoon, Chairman Grassley, Ranking Member Baucus, and members of

the committee. I am delighted to be invited before you to discuss the single-employer defined benefit pension system and the Pension Benefit Guarantee Corporation (PBGC). I applaud the committee for taking up this important and complicated

issue at this time, because I believe that the system is in crisis and in urgent need

of fundamental reforms. It is a ticking time bomb waiting to explode, and the longer

we wait to defuse it, the more powerful the blast will be.

The PBGC, a government-sponsored enterprise that takes over the pension obligations of financially troubled firms, reported a deficit of $23.3 billion at the end of

the 2004 fiscal year, up from $11.2 billion a year earlier. The PBGC also projected

a ‘‘reasonably possible’’ exposure of roughly $96 billion. In its ‘‘base case’’ estimate,

the Center on Federal Financial Institutions, a non-partisan watchdog organization,

projects a $78 billion deficit for the PBGC. These are disturbingly large numbers

that are likely to grow over time if no reforms are undertaken. Simply standing idly

by and watching the deficits grow would undermine the security of the retirement

benefits of employees and retirees and expose the taxpayer to ever greater costs.

DEJA VU ALL OVER AGAIN: DON’T LET PBGC BECOME THE S&L CRISIS

OF THE NEW MILLENNIUM

The situation at the PBGC today closely parallels the situation in the Savings and

Loan industry and its insurer, the Federal Savings and Loan Insurance Corporation

(FSLIC), in the 1980s. First, the FSLIC was a government-sponsored enterprise that

insured deposits of S&Ls up to $100,000, much as the PBGC provides insurance for

pension plans up to a current maximum per retiree of approximately $45,000 per

year. Second, both the FSLIC and the PBGC financed themselves by levying insurance premiums. Third, in neither case did or does the premium vary with the risk

of the underlying thrift or employer. Fourth, a series of economic shocks caused financial trouble in thrifts and in industries using defined benefit pension plans. During the 1980s, higher interest rates and a sharp decline in real estate values in

many parts of the country, for example, pushed many thrifts either into insolvency

or to the brink of insolvency. The recession of 2001, the shocks of 9/11, and poor

investment choices have led many defined benefit plans to become significantly

under-funded, with estimates of this under-funding exceeding $400 billion. Fifth,

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these financial troubles led both the FSLIC and the PBGC to become effectively insolvent, that is, their expected liabilities far outstripped their assets.

The sixth, and the most disturbing parallel, is that many observers—both in the

1980s for the FSLIC and for the PBGC today—acknowledge that the agencies face

challenges but that the trouble is/was simply a temporary phenomenon. As the economy recovered from recession in the early 1980s, many argued that the thrift problem would right itself. Thus, no fundamental policy change was necessary. This is

the policy of ‘‘forbearance,’’ that is, wait and hope with fingers crossed. Many commentators are advocating the same wait and hope policy for pension system today.

As the sad history of the thrift crisis demonstrates, the wait and hope policy was

a disaster. Despite a robust overall economic growth after 1982, troubled thrifts

never recovered. Many took high risks, ultimately at taxpayer expense. This is the

so-called moral hazard problem: if you provide insurance at below market rates that

do not adequately adjust for risk, recipients of the insurance, especially those who

are in financial difficulties, will take on greater risk. They do this because they have

little to lose, that is, if the thrift is insolvent or financially troubled, the owners

have little or nothing at stake. The depositors don’t care because they know that

they have the guarantees, so troubled thrifts could continue to gather deposits, often

by paying slightly higher interest rates to attract large inflows of money. The taxpayer was left to bail-out the depositors at a cost exceeding $100 billion. If the trouble had been resolved earlier, the costs would have been much lower (see Kroszner

and Strahan 1996).

The current pension system suffers from exactly this moral hazard problem, and

forbearance will only make it worse. Firms falling into financial distress or in bankruptcy in particular tend to defer funding their pension obligations. The current system of funding rules allows firms to have significant pension funding gaps for long

periods with little or no consequence. In addition, much as in the S&L crisis, employers have an incentive to invest in excessively risky assets, hoping that a lucky

pay-off will make up for the funding gap. Since the PBGC provides the guarantees

of the obligations, the employees (much like the insured depositors in the S&Ls) are

willing to tolerate more funding shortfalls and risks in the pension system than they

otherwise would. In addition, the system provides an incentive for financially troubled employers to promise larger pension benefits in return for wage concessions,

and employees might accept this due to the PBGC guarantee. The ability of financially troubled firms to delay pension funding and offer continuing and, in some

cases, increased benefits despite large funding shortfalls and risky pension investments, is at the heart of the moral hazard problem in the pension system today (see

Kroszner 2003).

‘‘PROMPT CORRECTIVE ACTION’’ PROVISIONS OF FDICIA PROVIDE

GUIDELINES FOR PREVENTING CRISIS

To avoid an enormous and inappropriate taxpayer-financed bail-out of the PBGC,

action must be taken swiftly. Fortunately, we can learn from the S&L experience

what should be done. The 1991 Federal Deposit Insurance Corporation Improvement

Act (FDICIA) introduced two important changes that have dramatically reduced

moral hazard in the depository institutions and have helped to strengthen the industry so that it could weather recession and shocks from 9/11 with very few failures or troubles. Depository institutions have been thriving since these changes

were implemented.

FDICIA permitted insurance premiums to increase to provide greater assets for

the deposit insurance agency to cover its obligations and, importantly, for the premiums to vary with risk. These were extremely important steps in returning the

deposit insurance system to solvency and reducing moral hazard. In the context of

PBGC, given its large and increasing deficits, it is clear that the current levels of

premiums are below the actuarially appropriate level. Thus, increasing premiums

will help to increase the security of insured retirement benefits and reduce the potential exposure of the taxpayers.

In addition, premiums must be permitted to adjust for the risk. The application

of this basic principle of economics and finance has done much to reduce the moral

hazard incentives to take on excessive risk. If premiums vary with risk, then thrifts

and employers will have to pay a cost of taking on excessive risk, unlike in a system

premiums that are not risk-sensitive. When premiums are not risk-adjusted, the

guarantee system effectively subsidizes risk taken, and ultimately the taxpayer may

bear the burden of these excessive risks. Thus, PBGC premiums should be adjusted

to take into account the risks that a particular plan poses. These include the extent

of the funding gap, the riskiness of the assets in the pension portfolio, and the likelihood that the PBGC will have to take over the obligations (e.g., a proxy for the probVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00077 Fmt 6601 Sfmt 6621 23367.000 SFINANC2 PsN: SFINANC2
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ability of financial distress, bankruptcy, and the ‘‘putting’’ of the pension obligations

to the PBGC). By structuring the premiums this way, firms are rewarded for funding their pension plans adequately and conservatively and are punished for underfunding and taking excessive risks. This is one important means of reigning in the

moral hazard problem and improving the retirement security of employees.

Another extremely important aspect of FDICIA that has helped to reduce moral

hazard problems is the requirement of ‘‘prompt corrective action’’ against depository

institutions that are in financial trouble and taking on excessive risk (see Kroszner

2000). As an institution falls into distress, prompt corrective action restricts the activities of the institution to reduce its risk-taking behavior and requires the institution to resolve its problems quickly. In the context of the current pension system,

the parallel to prompt corrective action would involve two reforms: first, eliminate

the ability of firms in distress to increase their (guaranteed) pension obligations;

and second, require that under-funded plans return to adequate funding levels

quickly. In the prompt corrective action provisions of FDICIA, the further that an

institution is out of compliance with its obligations, the more restrictions are put

on its activities and the greater the obligations to come into compliance. This graduated approach of taking the greatest actions against the plans with the greatest

shortfalls and risk makes much sense in the pension area also.

CONCLUSION

Without fundamental reform, the single-employer defined benefit system in the

U.S. faces a major crisis. To ensure the security of retirement benefits for employees

and retirees and to protect the system from inefficiencies of moral hazard (and

thereby reduce taxpayer exposure), reforms parallel to those introduced by the

FDICIA are necessary. In undertaking reform, I urge your committee to make a serious assessment of the objectives of the system and explore options that might involve harnessing greater use of market forces in achieving security of the pension

system without encouraging undue risk (see Kroszner 1999). One question that

arises is whether a government-sponsored enterprise is the best way to achieve the

objectives. For instance, the Congress has successfully moved Sallie Mae, the government-sponsored enterprise that guarantees student loans, into the private sector.

In the home mortgage area, private mortgage insurers provide guarantees that

allow many to purchase homes who otherwise could not receive a mortgage. Investigating the feasibility of some form of private insurance or of the purchase of annuities by employers for their employees would be valuable, in addition to the immediate reform of the PBGC.

Thank you very much for the honor of allowing me to express my views before

the committee, and I will be happy to answer any questions you may have.

References

Jeffrey Brown, Randall S. Kroszner, and Brian Jenn, ‘‘Federal Terrorism Risk Insurance,’’ National Tax Journal, September 2002, 55(3), 647–57.

Randall S. Kroszner, ‘‘Can the Financial Markets Privately Regulate Risk? The

Development of Derivatives Clearing Houses and Recent Over-the-Counter Innovations,’’ Journal of Money, Credit, and Banking, August 1999, 569–618.

Randall S. Kroszner, ‘‘The Economics and Politics of Financial Modernization,’’

Federal Reserve Bank of New York’s Economic Policy Review, October 2000, 25–37.

Randall S. Kroszner, ‘‘Taxpayer Exposure to Liabilities of the Pension Benefit

Guarantee Corporation,’’ Shadow Financial Regulatory Committee, Washington, DC,

Statement No. 198, September 22, 2003.

Randall S. Kroszner and Philip E. Strahan, ‘‘Regulatory Incentives and the Thrift

Crisis: Dividends, Mutual-to-Stock Conversions, and Financial Distress in the Thrift

Industry,’’ Journal of Finance, September 1996, 1285–1320.

RESPONSE TO A QUESTION FROM SENATOR BAUCUS

Question: In your testimony, you draw parallels between the Savings and Loan

crisis and the current PBGC deficit situation. You offer the success of FDIC reforms

as a model for ensuring the solvency of the defined benefit system and PBGC. Could

you comment on how the voluntary nature of the defined benefit system affects the

outcome of proposed reforms?

Answer: In my testimony, I described a number of close parallels between the

S&L crisis and the current difficulties with the defined pension system and the

PBGC. I then focused on two aspects of current proposed reforms that have parallels

in the legislative responses to the S&L crisis. First, insurance premiums were increased and related to risk of failure. Second, ‘‘prompt correct action’’ (PCA) provisions have required that regulators restrict activities of firms most at risk of failure

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to reduce risk-taking behavior and to demand that troubled firms act quickly to develop plans to resolve financial problems. I believe that these changes have been important in reducing moral hazard problems and reducing the potential exposure of

taxpayers.

As you note, participation in the defined benefit system is voluntary, that is, employers are not required to offer this particular form of pension, and employees may

opt for jobs with different pension schemes. I believe that the analysis in my testimony concerning the FDIC reforms does apply to the defined benefit pension system.

First, from an economic point of view, it is a problem if insurance premiums do

not reflect the underlying costs that the insurance imposes on the PBGC (and, potentially, upon the taxpayer). If premiums are set too low and do not adequately

reflect risks—much as during the 1980s in the S&L crisis—, then institutions will

have incentives to take on excessive risks, thereby potentially undermining the stability of the system as a whole and exposing the PBGC (and, potentially, the taxpayers) to large liabilities. The incentives given by the pricing of insurance affect

the voluntary actions of actors and institutions in the marketplace and lead them

to make choices involving excessive risk. Changing the premiums to better reflect

the expected liability exposure of the PBGC would likely change the choices that

market participants make, and would reduce risk and thereby enhance the stability

of the system.

Second, PCA also can be an important tool to affect the voluntary choices of actors

and institutions regarding the defined benefit pension system. As we observed during the S&L crisis, businesses that are facing distress may choose to take on excessive risks, particularly when the depositors or the pensioners have FDIC or PBGC

insurance. PCA can restrict those choices to reduce the risk-taking behavior and,

thereby, help to reduce the exposure of the guaranteeing institution, such as the

PBGC (and, potentially, the taxpayer). Preventing a distressed firm from increasing

its (guaranteed) pension obligations and requiring prompt remedial action for significantly under-funded plans can be valuable tools for ensuring the health of the

defined benefit pension system and the PBGC.

PREPARED STATEMENT OF ALAN REUTHER

INTRODUCTION

The UAW appreciates the opportunity to testify before the Senate Finance Committee on the financial position of the Pension Benefit Guaranty Corporation

(PBGC) and the administration’s funding proposals for single-employer defined benefit pension plans (hereinafter referred to as ‘‘pension plans’’). We look forward to

working with the committee as it considers these important issues.

The UAW represents 1,150,000 active and retired employees in the automobile,

aerospace, agricultural implement and other industries. Most of our active and retired members are covered under negotiated pension plans.

The UAW has a long and proud history of involvement in legislation relating to

these pension plans. We were in the forefront of the decade-long struggle to enact

ERISA, which led to the establishment of the PBGC. We also were actively involved

in the enactment of legislation in 1987 and again in 1994 to strengthen the funding

of pension plans and the PBGC.

The UAW believes Congress once again needs to adopt balanced proposals that

will strengthen the funding of pension plans and encourage employers to continue

these plans. We also support new measures to bolster the PBGC and the security

of pension benefits for workers and retirees.

Unfortunately, the package of proposals advanced by the administration will not

achieve these objectives. In our judgment, the administration’s pension proposals

are dangerous and counterproductive. They would punish employers who are already experiencing financial difficulties, resulting in more pension plan terminations and loss of retirement benefits, more bankruptcies, plants closings and layoffs, more liabilities being dumped on the PBGC, and more employers choosing to

exit the defined benefit pension system. As a result, these proposals would be bad

for employers, bad for workers and retirees, bad for the PBGC and bad for the entire defined benefit pension system.

The UAW urges the Finance Committee to reject the administration’s proposals,

and instead to put forward a bipartisan package of proposals that will improve the

funding of pension plans and bolster the PBGC, without punishing employers, workers and retirees. We stand prepared to work with the committee to achieve these

objectives.

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I. STRENGTHENING THE FUNDING OF PENSION PLANS

The UAW supports balanced legislation to strengthen the funding of pension

plans. These reforms should be designed to ensure that benefits promised by employers to workers and retirees are adequately funded, thereby improving the security of these benefits and also reducing the PBGC’s exposure for unfunded pension

liabilities.

However, the UAW believes it is imperative that any new funding rules should

be structured so as to provide predictable, stable funding obligations for employers

and to reduce the volatility of required contributions from year to year. New funding

rules should also encourage employers to contribute more than the bare minimum

in good times, and avoid counter-cyclical requirements that punish employers during

economic downturns.

Unfortunately, the funding proposals advanced by the administration fail to meet

these common-sense objectives. The UAW strongly opposes the administration’s

funding proposals because they would result in highly volatile pension funding obligations, would reduce incentives for employers to contribute more than the bare

minimum, and would punish employers who are already experiencing economic difficulties.

(A) Interest rate assumption

The UAW strongly opposes the administration’s proposal to require employers to

use a so-called yield curve in establishing the interest rate assumption for pension

plans. Under this proposal, the interest rate would be based on a near-spot rate

(averaged over only 90 days), with a different interest rate being applied to each

payment expected to be made by the plan based on the date on which that payment

will be made.

This proposal has a number of fundamental problems. First, it would be extremely

complicated, imposing considerable administrative burdens on plan sponsors. These

burdens may discourage employers from continuing defined benefit pension plans

(especially small- and mid-sized companies).

Second, contrary to the administration’s assertions, the yield curve would not provide greater ‘‘accuracy’’ in setting the interest rate assumption. Because there is no

real market for corporate bonds of many durations, these interest rates would largely be fictitious.

Third, the yield curve would result in highly volatile funding requirements that

would fluctuate widely as interest rates change over time. This increased volatility

would create enormous difficulties for employers, who need stability and predictability in their funding obligations. Indeed, the increased volatility would be a powerful incentive for employers to exit the defined benefit system.

Fourth, the yield curve would impose higher funding obligations on older manufacturing companies that have larger numbers of retirees and older workers. As a

result, it would exacerbate the competitive disadvantage that many of the companies currently have because of heavy legacy costs, and would punish companies that

are already experiencing economic difficulties.

Instead of this dangerous and counterproductive yield curve proposal, the UAW

urges the Finance Committee to make permanent the long-term corporate bond interest rate assumption that was included in the temporary legislation enacted by

Congress last year. In our judgment, this long-term corporate bond interest rate assumption would provide an economically sound and accurate basis for valuing pension liabilities, would be administratively simple for plan sponsors to implement,

would result in stable and predictable funding obligations for employers, and would

avoid imposing unfair, counter-cyclical funding burdens on older manufacturing

companies.

At the same time, the UAW urges the Finance Committee to allow employers to

use collar-adjusted mortality tables in valuing their plan liabilities. This would enable employers to more accurately value the future benefit obligations, especially for

older manufacturing companies with larger numbers of retirees and older workers.

(B) Improving plan funding

The UAW strongly opposes the administration’s proposal to throw out the existing

funding rules in their entirety, and to replace them with new funding rules based

on spot valuations of assets and liabilities, with no smoothing mechanisms, and with

funding targets tied to a company’s credit rating. These changes would introduce an

enormous element of volatility into pension funding requirements. This would make

it much more difficult for companies to plan their cash flow and liability projections,

and thus would provide yet another powerful incentive for employers to exit the defined benefit pension system. In addition, these changes would punish companies

that are already experiencing economic difficulties and have poor credit ratings, by

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imposing sharply higher funding obligations on these employers. The net result

could be more bankruptcies, job loss and plan terminations, with even more unfunded liabilities being transferred to the PBGC.

Instead of this counterproductive approach, the UAW urges the Finance Committee to support changes in the existing deficit reduction contribution (DRC) rules

that would lead to improved funding of pension plans, but also provide smoother,

more predictable funding obligations for employers and less onerous, counter-cyclical

burdens on employers experiencing a temporary downturn. We believe this could be

accomplished through two changes: (1) modifying the trigger for the DRC so that

it applies to a broader universe of plans, and also is triggered more quickly when

a plan becomes less than fully funded; and (2) reducing the percentage of the funding shortfall that must be made up in any year, so there will be a smoother path

towards full funding. These changes would help to ensure that more employers are

required to make up funding shortfalls in their plans, and are required to begin taking this action sooner. At the same time, these changes would avoid wild swings

in a company’s funding obligations that can have negative, counter-cyclical effects,

especially on employers who are already experiencing economic difficulties.

The UAW also urges the Finance Committee to adopt changes to the general

ERISA funding rules to shorten the amortization period for plan amendments from

30 to 15 years. This would bring this amortization period more in line with the average remaining working life of most participants. It would require more rapid funding of benefit improvements, and thereby help to improve the overall funding of pension plans.

Finally, the UAW supports modifying the definition of ‘‘current liability’’ to take

into account lump-sum distributions reasonably projected to be taken by plan participants. This would require plans to provide adequate funding to cover anticipated

lump-sum distributions, and help to prevent situations where plans have been

drained because of such distributions.

(C) Credit balances

The UAW strongly opposes the administration’s proposal to completely eliminate

credit balances, which are currently created when an employer contributes more

than the minimum required under existing funding rules. By eliminating credit balances entirely, the administration’s proposal would have the perverse effect of discouraging companies from contributing more than the bare minimum during good

economic times. This, in turn, could make the funded status of pension plans even

worse.

Instead of this counterproductive approach, the UAW urges the Finance Committee to modify the existing rules regarding credit balances on a prospective basis,

so that employers are required to value new credit balances according to the actual

market performance of the extra amounts contributed by the employer. This would

eliminate problems that have arisen when the actual market performance diverges

from plan assumptions. But it would still preserve the important incentive that

credit balances provide for employers to contribute more than the minimum required under the funding rules.

The UAW also supports increasing the deduction limit from 100 percent to 130

percent of current liability. This would allow employers to contribute more during

good economic times, and to build up a bigger cushion to help during economic

downturns.

In addition, the UAW supports modifying the current rules on the use of excess

pension assets, so that employers are allowed to use these assets for health care expenditures for active and retired employees, not just for retirees. This would provide

yet another incentive for employers to better fund their pension plans during good

economic times, by providing greater assurance that companies can always benefit

economically from surplus pension assets.

(D) Limits on benefits

The UAW strongly opposes the administration’s proposals to place strict, arbitrary

limits on benefits provided by pension plans that are less than 100 percent funded.

These proposals would have a sharply negative impact on workers and retirees. In

effect, they would reduce the adequacy of retirement benefits provided by pension

plans to tens of thousands of workers and retirees. We are particularly troubled by

the administration’s proposals to freeze benefit accruals, which would have an especially devastating impact on workers and their families.

The UAW is also outraged by the administration’s radical proposal to prohibit

pension plans from even offering plant-closing benefits. These types of benefits have

been an important means of cushioning the economic impact of plant closings as

companies struggle to reorganize. By making it possible for more workers to retire

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with an adequate income, these benefits reduce the number of workers who have

to be laid off and wind up drawing unemployment insurance and retraining benefits.

It makes no sense, therefore, to prohibit plans from even offering this type of benefit.

The UAW also is concerned about the discriminatory impact of the administration’s proposals on blue-collar workers and retirees covered under so-called flat-dollar plans. It is patently unfair to place restrictions on benefit improvements in flatdollar plans where the parties simply attempt to adjust benefits in accordance with

the growth in wages, but to allow the benefit improvements that occur automatically

in salary-related plans for white collar and management personnel. In our judgment, any proposals should treat both types of plans in an even-handed manner.

Contrary to the impression created by the administration, current law does not

allow employers and unions to ‘‘conspire’’ to increase benefits without regard to the

funded status of a pension plan, and to then terminate the plan and dump these

unfunded benefit promises onto the PBGC. By virtue of the 5-year phase-in rule,

the PBGC may not fully guarantee all benefit improvements preceding a plan termination. Thus, so-called ‘‘death bed’’ benefit increases are not guaranteed and do not

result in any increase in the PBGC’s liabilities.

The UAW does recognize that pension plans that are less than fully funded have

experienced problems with the payment of lump-sum distributions. In some cases,

the payment of lump sums has drained assets from these plans, unnecessarily jeopardizing the continuation of the plans and the payment of benefits to other participants and beneficiaries. Thus, the UAW would support reasonable limitations on the

payment of lump sums in such plans.

In addition, the UAW supports the enactment of a new ‘‘plan reorganization’’ process for under-funded plans in situations where the employer has filed for chapter

11 bankruptcy reorganization. We believe that this type of process could provide better flexibility in the adjustment of benefits and funding obligations, and thereby enable more companies in financial distress to continue their pension plans. This

would be beneficial for the participants and beneficiaries because it would allow

them to still have their pension plan and to keep some benefits that would otherwise be lost in the event of a plan termination. At the same time, this would be

beneficial for the PBGC because it would require the employer to continue making

some contributions to the plan and prevent the unfunded liabilities from being

transferred to the PBGC. Employers would also benefit from this plan reorganization option because it would provide greater flexibility in adjusting benefits and

funding obligations, so that continuation of the pension plan becomes manageable.

To make sure that this plan reorganization process is not abused, the UAW believes it should only be available to employers that have already taken the difficult

step of filing for chapter 11 bankruptcy reorganization. Furthermore, the bankruptcy court should be empowered to approve benefit and funding modifications beyond those already permitted under current law only if they are approved by all of

the stakeholders: that is, by the PBGC, the employer, and union (or, in the case of

non-represented participants, an independent fiduciary appointed by the bankruptcy

court). Finally, the permissible benefit modifications should be restricted to nonguaranteed benefits that would be lost anyway in the event of a plan termination.

Permissible funding modifications should extend to 30-year amortization of existing

unfunded liabilities.

The UAW believes that this type of plan reorganization process could be a powerful tool for enabling struggling employers to continue their pension plans, while protecting workers and retirees to the maximum extent feasible, and also reducing the

exposure of the PBGC. This process could provide the flexibility that is needed to

address different economic situations that are presented in chapter 11 cases, rather

than the one-size fits all approach proposed by the administration.

(E) Cash balance plans

The UAW believes that traditional defined benefit pension plans are better for

workers and retirees than cash balance plans. At the same time, we recognize that

cash balance plans are better than defined contribution plans or no pension plan

at all. In recent years, the UAW has negotiated cash balance plans to cover new

employees at Delphi, Visteon and other auto parts companies. This recognizes the

difficult economic situations facing domestic producers in this industry.

Unfortunately, the continuing legal uncertainty concerning cash balance plans is

causing some employers to shift to defined contribution plans or not to offer any

pension plan at all. This was vividly demonstrated by the recent announcement by

IBM that it would only provide a defined contribution plan for future employees.

This trend is disturbing, both because it is bad for the future retirement income seVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00082 Fmt 6601 Sfmt 6621 23367.000 SFINANC2 PsN: SFINANC2
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curity of workers and retirees, and because it could further undermine the premium

base for the PBGC.

For these reasons, the UAW supports legislation to resolve the legal uncertainties

surrounding cash balance plans, by making it clear that they are not per se a violation of age discrimination laws. We also support allowing greater flexibility for cash

balance plans in setting interest credits. At the same time, in situations where a

traditional defined benefit plan is converted to a cash balance plan, we believe reasonable transition relief should be provided to older workers who are near retirement. This combination of reforms would protect the legitimate retirement expectations of older workers, while at the same time allowing employers to remain in the

defined benefit pension system (and continuing paying premiums to the PBGC)

through the vehicle of cash balance plans.

II. PENSION BENEFIT GUARANTY CORPORATION (PBGC)

It is important, at the outset, to underscore that there is no ‘‘crisis’’ at the PBGC.

As the administration has admitted, the PBGC has sufficient assets to pay all guaranteed benefits for many years to come (at least until 2020, and possibly longer).

Thus, the reports about the PBGC’s growing deficit should not create a stampede

towards extreme, counterproductive proposals. Congress should approach this issue

in a deliberative manner, and make sure that any remedies do not cause more harm

to workers, retirees, employers and the defined benefit pension system.

There is no mystery about what has caused the PBGC to have a growing deficit.

In the recent past the PBGC was projecting a significant surplus. But bankruptcies

in the steel industry led to the terminations of a number of pension plans with the

largest unfunded liabilities ever assumed by the PBGC. Now, bankruptcies in the

airlines industry are threatening to result in plan terminations with even bigger unfunded liabilities. Thus, there is no dispute that the PBGC’s deficit is directly attributable to the widespread economic difficulties and bankruptcies in the steel and airline industries.

Unfortunately, the administration has come forward with three dangerous and

counterproductive proposals to address the PBGC’s projected deficit. In our judgment, these proposals would unfairly punish workers and retirees. They would also

punish employers who are already experiencing economic difficulties, leading to

more bankruptcies and job loss, as well as more plan terminations. Moreover, these

proposals would encourage employers to exit the defined benefit system, increasing

the danger of even bigger pension liabilities being transferred to the PBGC.

(A) Premium increases

The UAW opposes the administration’s proposal to drastically increase the flat

premium paid by all sponsors of single-employer defined benefit pension plans from

$19 to $30, and to index the premium for future increases in wages. We also oppose

the administration’s proposal to impose a huge increase in the variable-rate premium charged to employers that sponsor plans that are less than fully funded, and

to have the amount of this variable-rate premium vary depending on the credit rating of a company.

First, the magnitude of these premium increases would impose significant economic burdens on many companies. This would be especially hard on companies

that are already experiencing economic difficulties and on medium-sized and small

businesses. It would also exacerbate the competitive disadvantage for many older

manufacturing companies with large legacy costs.

Second, the change in the structure of the variable-rate premium—specifically,

linking it to a company’s credit rating—would have the perverse effect of punishing

companies that are already in difficult economic situations. Again, this would exacerbate the competitive disadvantage facing many older manufacturing companies.

In light of these factors, the UAW believes the administration’s premium proposals would be counterproductive. At a minimum, these proposals would encourage

an exodus of employers from the defined benefit pension system. This could undermine the retirement income security of millions of workers and retirees. It would

also narrow the premium base for the PBGC, and thereby increase its financial difficulties. In the end, there is a real danger that the PBGC and the defined benefit

pension system could enter into a death spiral, with a constantly shrinking premium base and growth in the pension liabilities being transferred to the PBGC.

(B) PBGC guarantees

The UAW opposes the administration’s proposals to cut the PBGC guarantees.

These include freezing the guarantees when an employer files for chapter 11 bankruptcy, and effectively eliminating any guarantee for plant-closing benefits. These

changes would unfairly punish tens of thousands of workers and retirees, reducing

80

their retirement benefits and leaving them with a sharply reduced standard of living.

It is important to emphasize that, under current law, workers and retirees often

lose a portion of their benefits when a plan is terminated. Because of the 5-year

phase-in rule and other limits, workers and retirees typically lose a portion of their

benefits attributable to recent benefit improvements and certain early retirement

benefits. The UAW believes that these benefit losses should not be made worse by

further reductions in the scope of the PBGC guarantees.

(C) PBGC lien for unpaid contributions

The UAW opposes the administration’s proposal to give the PBGC a lien in bankruptcy proceedings for any unpaid pension contributions. This would punish troubled companies and their retirees, and lead to more liquidations, lost jobs and lost

retiree health benefits. It could also result in more plan terminations and even

greater pension liabilities being transferred to the PBGC.

Companies do not lightly take the step of filing for chapter 11 bankruptcy. They

do so only when they are experiencing significant economic difficulties and are unable to pay all debts when due. Chapter 11 bankruptcy, by definition, is a zero-sum

situation. To the extent one creditor is given a higher priority or greater claim on

the company’s assets, this necessarily means that the other creditors will receive

less.

Thus, granting the PBGC a lien against a company’s assets for any unpaid pension contributions necessarily means that other creditors—lending institutions, suppliers and other vendors, and the workers and retirees—would recover less. This

would inevitably trigger a number of counterproductive, harmful consequences.

First, lenders would be more reluctant to provide the financing that is critically

important to ensuring the successful reorganization of companies in chapter 11 proceedings. Without this financing, there would be more liquidations and hence more

job loss. Even worse, the negative ramifications on the lending community would

extend to companies that have not yet filed for chapter 11 bankruptcy, but who are

experiencing economic difficulties and are potential candidates for chapter 11. To

protect themselves, lenders would be forced to charge higher costs to these troubled

companies or even refuse financing. The end result could be more bankruptcies, and

even more job loss.

Second, retirees would be particularly hard hit by any PBGC lien for unpaid pension contributions, since this would significantly reduce their ability to collect on

claims for retiree health insurance benefits. In many of the chapter 11 cases where

there is an under-funded pension plan, the single biggest group of unsecured creditors are the retirees with their claim for health insurance benefits. If the PBGC is

given a lien for unpaid pension contributions, the practical result would often be

that there are no assets left to provide any retiree health insurance benefits. Thus,

the net result of increasing the PBGC’s recovery would be to punish the retirees—

the very people the PBGC was created to protect.

Third, other suppliers and vendors would also be negatively impacted by the

granting of a lien to the PBGC for unpaid pension contributions. In many bankruptcies, this means that these other businesses would get a significantly reduced

recovery for their claims. This could jeopardize their ability to continue in business,

leading to a chain reaction of more bankruptcies and job loss.

Fourth, it is highly questionable whether the PBGC would ultimately benefit by

being granted a lien for unpaid pension contributions. To the extent this proposal

forces more companies to liquidate more quickly, there would be more plan terminations and even more pension liabilities transferred to the PBGC.

The PBGC already has significant leverage in bankruptcy proceedings because of

the enormous claims it has for unfunded liabilities, and because of its ability to affect the timing and other aspects of plan terminations. There is simply no need to

increase the PBGC’s leverage, to the detriment of workers, retirees, employers, and

the entire defined benefit pension system.

(D) A positive approach to strengthening the PBGC

Instead of the harmful, counterproductive proposals advanced by the administration, the UAW believes that the PBGC can be strengthened through a number of

approaches that would protect the interests of workers and retirees, employers and

the entire defined benefit pension system.

First, the UAW believes that the overall funding of pension plans can be strengthened through the reforms we have previously supported in Section I of this testimony. By taking steps now to improve the funding of pension plans, Congress can

improve the security of benefits for workers and retirees, and also reduce the longterm exposure of the PBGC. These reforms can also encourage employers to conVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00084 Fmt 6601 Sfmt 6621 23367.000 SFINANC2 PsN: SFINANC2
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tinue defined benefit pension plans, while avoiding counterproductive burdens on

employers who are experiencing economic difficulties.

Second, the UAW believes that the plan reorganization process discussed previously in Section I of this testimony can be especially helpful in reducing the number of bankruptcy cases that lead to pension plan terminations and liabilities being

transferred to the PBGC. In particular, we believe this type of process could be important immediately in providing the flexibility necessary for United and other airlines to continue their pension plans, instead of terminating them. This would significantly reduce the PBGC’s deficit, by keeping these airline pension liabilities from

being transferred to the PBGC. It would also benefit the workers and retirees at

these airline companies, by keeping their pension plans going and allowing them to

receive greater benefits than they would if the plans were terminated. At the same

time, this reorganization process could provide significant economic relief to the

troubled airlines, while still requiring them to continue some level of pension contributions. The same combination of factors could also make this type of reorganization process helpful in other industries, thereby reducing the PBGC’s future exposure for pension liabilities.

Third, the UAW believes that the best way to deal with the steel and airline pension liabilities that have already or will soon be assumed by the PBGC is to have

the Federal Government finance these liabilities over a 30-year period. This could

be accomplished by having the Federal Government (or the PBGC) issue 30-year

bonds, and then have the Federal Government pay the interest on these bonds as

it comes due. We believe this approach would cost the Federal Government about

$1–2 billion per year, depending on the magnitude of the airline pension liabilities

that are ultimately assumed by the PBGC.

The UAW recognizes that the Federal Government is already running substantial

budget deficits. But this infusion of Federal funds to strengthen the PBGC can easily be afforded by our Nation. For example, in its current budget, the administration

has proposed significant increases in the amounts that individuals can contribute

to various individual retirement and savings accounts (so-called RSAs and LSAs).

This involves a substantial tax expenditure that will flow overwhelmingly to upper

income individuals. The Congressional Research Service has estimated that this proposal will cost the equivalent today of $300 to $500 billion over 10 years. The UAW

submits that these funds could better be used to strengthen the PBGC and protect

the retirement benefits of average working families in defined benefit pension plans.

Whatever the difficulties, the fact remains that using general revenues to gradually finance the PBGC’s steel- and airline-related pension deficit is better than all

of the other options currently being considered. Specifically, it is better than punishing workers and retirees by cutting the PBGC guarantees. It is better than punishing companies that sponsor pension plans by drastically increasing their PBGC

premiums. And it is better than punishing companies that are experiencing financial distress by giving the PBGC a greater claim in bankruptcy proceedings. These

other options will inevitably hurt workers and retirees and employers that sponsor

pension plans. They will also lead to more bankruptcies and job loss. And they will

drive employers away from the defined benefit pension system, creating a death spiral for the PBGC.

The truth is the PBGC was never designed to handle widespread bankruptcies

and pension plan terminations across entire industries, as we have seen in steel and

are now witnessing in airlines. Indeed, the seminal case that led to the creation of

the PBGC was the Studebaker situation, in which a single auto company went out

of business and terminated its pension plan. Obviously, the entire auto industry did

not go bankrupt or terminate its pension plans then.

When the PBGC was created by Congress, it was modeled after the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits for individuals.

The FDIC was designed to handle isolated bank failures, not the collapse of a broad

section of the banking industry. When the savings and loan crisis occurred in the

1980s, Congress wisely recognized that the costs associated with S&L failures

should not be shifted onto the backs of individual depositors, nor onto the backs of

other banking institutions. Congress recognized that those alternatives would impose unacceptable hardships on individuals and other banks, and would have a

counterproductive impact on the rest of the banking system and our entire economy.

As a result, Congress decided to have the Federal Government finance the S&L liabilities over many years, at a cost of hundreds of billions of dollars.

The same principles make sense in the case of the steel and airline pension liabilities that have or will be assumed by the PBGC. Shifting those costs onto workers

and retirees or employers that sponsor pension plans would simply lead to unacceptable hardships and counterproductive economic consequences. The best approach—

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panies and for our entire economy—is to spread those costs gradually and broadly

across society by having the Federal Government finance them over 30 years.

This approach would not reward ‘‘bad actors.’’ The steel and airline bankruptcies

and pension plan terminations were caused by many factors, including the policies

(or non-policies) of the Federal Government relating to trade, deregulation, energy

and health care, as well as the shocks flowing from the terrorist attacks on September 11th. In our judgment, it is entirely appropriate to now ask the Federal Government to help pay for the pension costs flowing from those policies and events.

Indeed, Congress and the Finance Committee already have endorsed this notion

in a more limited context. In the Trade Act of 2002, Congress provided for a new

65-percent tax credit to pay for retiree health benefits for retirees whose pension

plans have been terminated and taken over by the PBGC, and who are between the

ages of 55–65. Through this provision, Congress effectively used general revenues

to pay for part of the costs associated with providing retiree health benefits to this

group of retirees. This provision was designed primarily as a response to the bankruptcies (and pension plan terminations) in the steel industry, which had resulted

in thousands of steelworker retirees losing their health benefits. It reflected a recognition by Congress that our trade and health care policies had played a role in

the steel company bankruptcies and the loss of retiree health benefits. The UAW

submits that the same principles now justify using general revenues to pay for the

pension costs flowing from the steel and airline bankruptcies and plan terminations.

Similarly, Congress has a long history of using general revenues to respond to disasters across our Nation. This includes floods, hurricanes, droughts and many other

types of catastrophes. The UAW submits that the devastation that has occurred in

our steel and airlines industries is no less worthy of Federal assistance.

There is no danger this type of approach will create a ‘‘moral hazard’’ leading to

worse pension funding and more problems in the future. This is because the UAW

is proposing that the infusion of general revenues to pay for the airline and steel

pension liabilities be coupled with the package of reforms to strengthen the funding

of other pension plans and with the new plan reorganization process that will help

troubled companies to continue their pension plans and reduce the future exposure

of the PBGC.

CONCLUSION

The UAW appreciates this opportunity to testify before the Finance Committee to

express our views on the administration’s proposals relating to the funding of pension plans and the financial stability of the PBGC. We urge the committee to reject

the administration’s harmful and counterproductive proposals, and instead to fashion a constructive package that will strengthen the funding of pension plans, protect

workers and retirees, provide stability and predictability to employers that sponsor

pension plans and encourage them to remain in the defined benefit pension system,

and place the PBGC on a sound and sustainable path.

We look forward to working with members of the Finance Committee as you consider these important pension issues. Thank you.

RESPONSES TO QUESTIONS FROM SENATOR BAUCUS

Question: I would like to follow up on your idea about reorganization.

(a) What kind of compromises would you expect through the reorganization process?

(b) Would the idea work pre-bankruptcy?

Answer: (a) Under current law, when a company has filed for chapter 11 bankruptcy, the bankruptcy court is limited to the options of freezing or terminating the

pension plan. The UAW believes it would be better to give the bankruptcy court

more flexibility to approve plan funding and benefit modifications that have been

worked out by all of the stakeholders (the PBGC, the company, and the union or

representative of non-organized workers and retirees). This could lead to plan modifications that would be in between the options of freezing or terminating the plan.

For example, it could lead to non-guaranteed benefits being scaled back or eliminated, and funding obligations being extended over a lengthy (e.g., 30-year) time period.

The PBGC would obviously benefit if the plan is continued in this manner, since

no liabilities would be transferred to the PBGC. Also, the unfunded liabilities would

be reduced if some non-guaranteed benefits are cut, and the employer is still required to make some level of contributions.

The workers and retirees would benefit by having their plan continued, rather

than being terminated. Even though some non-guaranteed benefits might be lost,

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the reorganization process might accomplish this in a fairer and more flexible manner than would termination.

Finally, the company could also benefit, since the continued funding obligation

would be less than that required under a freezing of the plan (because of the longer

funding period and the reduction or elimination of some benefits). This lesser funding obligation might be preferable to a company than the negative cash flow consequences that could result if the plan is terminated and the PBGC immediately

pursues its claim for the entire unfunded pension liability.

(b) The UAW does not believe the plan reorganization process should be available

pre-bankruptcy. This would open up the possibility of abuse by employers who

might try to use the process simply to get rid of certain pension benefits. By providing the reorganization process only in bankruptcy situations, Congress can ensure that this process is only used in cases where the employer is genuinely in financial difficulty. In addition, this would ensure that the neutral bankruptcy court

oversees the reorganization process. We do not believe it is appropriate to allow any

of the stakeholders—and especially the PBGC—to unilaterally control the process,

since that would unfairly skew the outcome towards the interests of that particular

stakeholder.

Question: Do you think that if the administration’s proposals were enacted, the

UAW would push for higher contributions to their defined benefit plans?

Answer: The UAW has already pushed for higher contributions by companies to

our negotiated pension plans. For example, in the early 90s we pushed for General

Motors to increase funding to its pension plan.

Unfortunately, we do not believe the administration’s pension proposals would encourage bargaining for higher pension contributions. Rather, we are deeply concerned that the net result of these proposals would be to punish older manufacturing companies, by imposing sharply higher and more volatile pension funding

and premium requirements on them. This could exacerbate the competitive disadvantages they already face because of heavy legacy costs. This in turn could lead

to more plant closings and even trigger bankruptcies. The end result could be more

lost jobs and benefits, and even more plan terminations with even greater liabilities

being transferred to the PBGC. Also, we are concerned this could trigger an exodus

of employers from the defined benefit pension system, which would harm workers

and retirees and possibly result in a death spiral for the PBGC as well as what is

left of the defined benefit pension system.

RESPONSE TO A QUESTION FROM SENATOR HATCH

Question: Mr. Reuther, you mentioned in your testimony that UAW believes that

traditional defined benefit pension plans are better for workers and retirees than

cash balance plans. Many experts believe that cash balance plans are superior to

traditional DB plans for many workers, including younger employees and those in

high technology industries. Does the UAW really believe that cash balance plans are

inferior in every case, even for your younger employees who might not spend their

entire lives in one company?

Answer: In industries where workers tend to stay with a single-employer for most

of their working careers, the UAW believes that traditional defined benefit pension

plans are the best vehicle for providing workers with a stable and adequate retirement income. Traditional defined benefit plans provide workers with a lifetime

stream of specific monthly benefits. These plans can also provide early retirement,

disability and other types of pension benefits to address the needs of working families.

The UAW recognizes that in industries where employees only stay a short time

with a single company, cash balance plans may be a better means of providing retirement income to workers than defined contribution plans. Certainly, cash balance

plans are better than no pension plan at all. That is why the UAW supports legislation to resolve the legal uncertainties surrounding cash balance plans, by making

it clear that they are not per se a violation of age discrimination laws.

PREPARED STATEMENT OF HON. JOHN D. ROCKEFELLER IV

Mr. Chairman, thank you very much for holding this hearing. Congress has important work to do this year updating the laws that govern our defined benefit pension plan system. My own hope is that we can find a way to make the system more

sound, protect workers’ promised pensions, and encourage employers to continue to

provide these valuable benefits. I have some serious concerns about whether

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changes the administration has proposed represent true progress toward those

goals.

Less than 20 years ago, there were more than 130,000 defined benefit plans offered to workers around the country. Because many employers have shifted toward

defined contribution plans, under which workers and retirees bear more risk, there

are now fewer than 35,000 traditional pension plans in operation. This worries me

because I understand how important the guarantee of a defined benefit pension can

be.

I stand ready to work with my colleagues on this committee and the administration in crafting reforms to the pension system that will guarantee adequate funding

of pension plans and provide appropriate premium revenue to the Pension Benefit

Guaranty Corporation which insures those plans. However, I am concerned that

many of the changes suggested by the administration might impose such unreasonable burdens on plan sponsors that employers will decide to leave the system.

The administration has proposed a yield curve that will dramatically increase the

liability calculation of many industries with older workers. The yield curve also introduces uncertainty, complexity, and volatility to the liability calculation—all

anathema to companies focused on the bottom line. Even for entirely healthy plans,

the administration has proposed dramatically increasing the premium payments,

making defined benefit pensions more expensive to maintain. I also expect to hear

considerable objection from companies to the notion of their pension liability calculations being determined by the whims of credit rating agencies which operate with

extremely little oversight.

I am concerned that all of those factors will make defined benefit pension plans

less attractive for employers. But my greatest concern with the administration’s proposal has to do with the increased risk it imposes on employees who are working

hard and holding up their end of the bargain. The administration proposes to punish workers for the sins of management. That is, benefit increases and benefit accruals will be frozen for workers whose companies under-fund pension plans. Such a

rule may actually create an incentive for management to under-fund pension plans,

eliminating hard-won benefits for employees. Certainly, employees do not have the

authority to direct the manner in which employers fund plans.

Finally, I am very concerned that the administration has made no proposal to address the pension crisis in the airline industry. A considerable amount of the deficit

facing the PBGC is expected to derive from failing airline pension plans. Yet the

administration has proposed no remedies specific to that industry that would help

airlines maintain their plans. Given the PBGC’s potential exposure to large liabilities associated with airline pensions, it is difficult to take seriously any reform proposal that ignores this industry’s situation.

I look forward to hearing the testimony of the witnesses today. I hope that they

will address some of the concerns I have outlined. And again, Mr. Chairman, I appreciate your holding this hearing to kick off this committee’s important work on

pensions.

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PREPARED STATEMENT OF HON. MARK J. WARSHAWSKY

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RESPONSES TO QUESTIONS FROM SENATOR BAUCUS

Question: Your funding proposal would appear to severely limit contributions in

times of high interest rates, which would seem to create sizable minimum contribution requirements when rates start to fall. Have you done modeling on the impact

of your proposal on contribution requirements in an interest rate environment

where rates have peaked and are headed down, like the mid-1980s? If so, please

describe the results.

Answer: We are concerned that some of those testifying as to the impact of the

maximum deductible contribution amount did not fully understand how expansive

our proposal is. The level up to which firms may make deductible contributions has

two cushions, not just one as has been cited: • first, to 130 percent of the plan’s funding target, and • second, an increase to reflect how much larger the funding target would be if

it were to take into account anticipated future salary and benefit increases.

In addition, every plan will be allowed to fund at least to at-risk liability.

We have modeled a wide range of economic environments. This modeling indicates

that the funding cushions are more than adequate to allow sponsors that fully utilize the additional funding opportunities to not see their plans become under-funded

solely as a result of asset and liability value fluctuations that occur over a business

cycle. Please see the White Paper on PBGC’s website at http://www.pbgc.gov/publications/white—papers/wp—040605.pdf for a full discussion of PBGC’s modeling.

Question: You commented that there are two problems with the current credit balance structure: the failure to credit actual investment returns and the availability

of contribution holidays for under-funded plans. Would crediting actual investment

gain or loss to credit balances address your concerns? What about actual rates of

return plus limiting application of the credit balance to amortization bases, not normal cost?

Answer: Because credit balances currently are not marked to market and can be

used by under-funded plan sponsors, they have, in many cases, resulted in plans

having lengthy funding holidays, while becoming increasingly under-funded. This

was the case in several of the pension insurance program’s largest losses to date,

such as Bethlehem Steel. It is critical to note that just marking credit balances to

market is not sufficient to solve the problem if under-funded plans are still able to

take funding holidays.

Though our proposal does away with ‘‘credit balances’’ as currently construed, it

preserves incentives to contribute above the minimum. Because the administration’s

proposed funding rules focus on the level of assets and accrued liabilities, pre-funding pays off in a reduction in future required minimum payments. Pre-funding adds

to a plan’s assets, thereby reducing any current shortfalls or the likelihood of potential future shortfalls relative to appropriately and accurately measured liabilities.

Question: Your proposal determines the yield curve with a 90-day averaging period. Since the yield curve does not have a constant shape, is there an upper limit

on the averaging period that generates a meaningful yield curve? For example, if

Congress decided the averaging period should be 2 years, would you still recommend

a yield curve instead of a single rate?

Answer: I would be very concerned about an averaging period of 2 years, regardless of whether the yield curve concept was implemented or not. As I discuss in my

testimony, smoothing asset or liability values over time masks economic reality. My

view is that there are significant risks associated with masking the underlying financial and economic reality of under-funded pension plans. Failure to recognize

risk because of the use of smoothing mechanisms results in transfers of risk among

parties, in particular from plan sponsors to plan participants and the PBGC. One

need only look at the losses incurred by many steel and airline plan participants

and PBGC’s net position to see this is so.

The 90-day period was chosen in order to remove interest rate ‘‘noise’’—short-term

fluctuations—that sometimes occurs over brief time periods. Our research suggests

that 90 days works well for this purpose.

RESPONSES TO QUESTIONS FROM SENATOR BUNNING

Question: I have always felt strongly that we needed to make changes to the funding rules in order to encourage companies to make higher contributions during good

economic times in order to help to ride out later tougher periods. I was pleased to

see that the administration has addressed this issue in your recent proposals. Can

you comment for me on the details of your proposal—particularly why you think

your proposal is better than other ideas to address this issue, such as raising the

allowable deductible contribution under the current rules from 100 percent of current liability to a higher percentage such as 125 percent or higher?

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Answer: The administration proposal does include a provision that will increase

the limit on deductible contributions. The proposal creates two funding cushions

that, when added to the appropriate funding target, would determine the upper

funding limit for tax-deductible contributions. In addition, every plan will be allowed

to fund at least to at-risk liability.

The first cushion is designed to allow firms to build a sufficient surplus so that

plans do not become under-funded solely as a result of asset and liability values

fluctuations that occur over a business cycle. This cushion allows funding to 130

percent of the funding target.

Plan sponsors would also be able to build a second funding cushion that allows

them to pre-fund for salary or benefit increases.

We believe that for most plan sponsors, the administration provides as much, and

likely more, pre-funding flexibility than the alternative you describe. We would be

happy to discuss this issue with you in more detail.

Question: As you know, one issue we have seen is the effect that an unexpected

number of lump-sum distributions can have on the health of a plan. Can you comment on the administration’s plans for addressing this issue of lump-sum distributions?

Answer: The proposal contains three measures to combat this problem. First, it

requires plans offering lump-sum payment options to account for future lump-sum

payments when calculating their liabilities.

Second, seriously under-funded pension plans would not be able to make lumpsum distributions under our proposal. Lump sum prohibitions would apply to plans

with financially weak sponsors that are 80 percent or less funded, and plans with

financially healthy sponsors that are 60 percent or less funded. This will protect

plan assets for participants who are not eligible for retirement or who prefer to receive an annuity.

Finally, under current law, the use of an inappropriately low discount rate for determining the value of lump sums creates an incentive for participants to choose

lump sums. Under our proposal, the yield curve would be used to calculate minimum lump sums, which will eliminate this distortion that can bias a participant’s

payout decision toward lump sums. This reform includes a transition period, so that

employees who are expecting to retire in the near future are not subject to an abrupt change in the amount of their lump sums as a result of changes in law. The

new basis would not apply to distributions in 2005 and 2006 and would be phased

in for distributions in 2007 and 2008, with full implementation beginning only in

2009.

Question: As you well know, there has been much criticism from the business

community and some unions regarding the yield curve that this committee passed

last year, based on the administration’s proposal, and its use in determining the applicable interest rate to value funding requirements. In particular, concerns have

been raised about complexity, accuracy, and volatility, and it has been argued that

the yield curve will hurt older manufacturing companies which have larger numbers

of retirees and older workers. Could you please address these criticisms?

Answer: As I explain in my written testimony, implementing the yield curve is

not complex. A simple numeric example included in that written testimony demonstrates how the yield curve can be used in computing pension liabilities.

We have seen no evidence that implementation of the yield curve will pose a difficult technical challenge for actuaries or that it will cause significant increases in

pension plan expenses.

Current rules attempt to insulate pension plans from financial market realities

through the smoothing of contributions, assets and liabilities. These rules were created in an attempt to reduce the year-to-year variation of sponsor pension contributions. Such smoothing has not only failed to accomplish this objective, but has created a set of perverse incentives that affect pension plans’ funding and investment

decisions. Artificial smoothing does not eliminate investment or under-funding risk

for a sponsor, nor does it redistribute such risks through time. The sponsor that

benefits from smoothing merely transfers these risks to other firms in the insurance

system.

The administration takes the view that pension rules should provide plan sponsors with the tools to manage volatility, including amortization over 7 years and

extra opportunity to pre-fund benefits in good times. The rules should encourage use

of these tools as well as available financial market tools to reduce contribution volatility, rather than artificially smoothing asset and liability values and distorting current economic reality. In order to encourage such behavior, assets and liabilities will

be measured on a current and accurate basis under the administration’s proposal.

Liabilities will be measured using a yield curve that matches appropriate market

interest rates to the time structure of the pension plan’s projected cash flows.

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The administration proposal also raises the ceiling on deductible contributions.

This will allow those plan sponsors to build funding surpluses in order to reduce

contribution volatility.

Use of the yield curve is a critical element in accurate measurement of liabilities.

Accurate measurement of liabilities does not in any way put any plans—including

those with older workforces and high numbers of retirees—at a disadvantage. The

pension benefit obligations that make up plan liabilities are not changed in any way

by use of the yield curve. The yield curve simply recognizes that older plans must

make a relatively high proportion of benefit payments in the near future. Conversely, use of the yield curve also recognizes that younger plans will make a high

proportion of benefit payments in the more distant future. Current law, by using

a single long-term bond rate to discount all future payments, largely ignores this

fact and therefore measures liabilities inaccurately.

Questions about how the yield curve is computed are addressed in a white paper

that appears on the Treasury website. The address for the white paper is: http:/

/www.treas.gov/offices/economic-policy/reports/pension—yieldcurve—020705.pdf.

Question: As are others on this committee, I am obviously concerned about the

state of our airline industry. Last year, some temporary relief was passed with regard to that industry’s pension plans despite the concerns of some that those temporary measures may cause the PBGC to be faced with a higher liability in the

event of an eventual PBGC takeover of some of these airline plans. I also understand that the PBGC’s estimates of their $23-billion fiscal deficit assume a number

of airline industry plan takeovers in its ‘‘probables.’’ Obviously, whatever we can do

to stop these plans from being taken over by the PBGC will be in the best interests

of both the airline employees and the taxpayers. I am hoping that we can examine

creative ways of allowing the airlines to fund the promises that they have made to

our constituents without increasing the potential liability of the PBGC and the taxpayers. What impact do you think the administration’s proposed funding rules

would have on the airline industry? Are you willing to work with this committee

to examine ways that the situation with the airline industry can be addressed while

meeting the dual goals of supporting the industry and its employees and protecting

the taxpayers from potential increased liability?

Answer: The administration proposal was designed to address problems in the single-employer defined benefit system as a whole. We did not model the effects on individual firms or industries. With respect to your concern about the effects of the

proposal on financially weak firms, it is important to bear in mind that the proposal

includes a 3-year transition period to the yield curve and extends amortization periods for many under-funded plan from as little as 4 years (under the deficit reduction

contribution) to 7 years.

We are willing to discuss any issues of interest to the committee. Current law and

the administration proposal will allow for the granting of temporary funding relief

to pension sponsors in temporary financial difficulty through the waiver process. In

general, we are opposed to specialized treatment for any one industry. The pension

insurance system is not designed to provide or capable of providing aid to companies

competing in restructuring industries. It is designed to insure benefits for participants in plans that fail.

RESPONSES TO QUESTIONS FROM SENATOR HATCH

Question: Mr. Warshawsky, I certainly share your concern about the need for reforming the funding rules for defined benefit plans. Do you believe that the administration’s proposal, if enacted in its entirety, would stave off the crisis facing the

PBGC?

Answer: Yes, we believe so. In our view, the existing funding rules for single-employer defined benefit pension plans and the current premium structure financing

the PBGC are the primary causes of the current crisis. We believe that if our proposal were enacted, plan funding would improve significantly and PBGC would be

restored to financial health.

The existing funding rules have a number of fundamental flaws that the proposal

addresses directly. Current funding rules attempt to insulate pension plans from financial market realities through smoothing mechanisms built into the measurement

of plan assets and liabilities. These rules were created in an attempt to reduce the

year-to-year variation of sponsor pension contributions. Such smoothing has not only

failed to accomplish this objective, but has contributed to the widespread plan

under-funding and mismeasurement we see today.

The administration takes the view that pension rules should provide plan sponsors with the tools to manage volatility, including amortization over 7 years and

extra opportunity to pre-fund benefits in good times. The rules should encourage use

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of these tools as well as available financial market tools to reduce contribution volatility rather than artificially smoothing asset and liability values and distorting current economic reality. In order to encourage such behavior, assets and liabilities will

be measured on a current and accurate basis under the administration’s proposal.

Liabilities will be measured using a yield curve that matches appropriate market

interest rates to the time structure of the pension plan’s projected cash flows.

The administration proposal also raises the ceiling on deductible contributions.

This will allow those plan sponsors to build funding surpluses in order to reduce

contribution volatility.

Current funding rules allow plans to stop making contributions before all accrued

benefits are funded, and credit balances allow under-funded plans to take funding

holidays. The administration proposal will require all plans to fund to a minimum

target that is at least equal to the value of accrued benefits. The proposal also eliminates credit balances.

Current rules also set the same funding target for all plans regardless of differences in the risk of termination. The administration’s proposal would recognize

the additional termination risks posed by plans sponsored by financially weak firms.

Such plans will be required to fund to a target commensurate to these risks.

Lastly, the current premium system provides little incentive for plans to remain

well-funded and generates insufficient revenue to cover losses in the pension insurance program. The system has relied primarily on flat premiums, per capita charges

that do not vary from plan to plan, to produce most of its revenues. The premium

rate of $19 per participant has not been raised since 1991 even though the PBGC’s

guarantee limits are annually indexed to wage growth. The administration proposal

would raise premiums immediately to $30 to account for wage growth since 1991.

Flat-rate premiums would be indexed in the future using the same index used to

update the guarantee limits.

Although there is a premium charge for plan under-funding in the current structure, many under-funded plans qualify for exemptions each year and do not pay that

premium. As long as under-funded plans are at the ‘‘full funding limit,’’ which generally means 90 percent of current liability, they do not have to pay the variablerate premium. That is why some of the companies that saddled the insurance fund

with its largest claims paid no variable-rate premium for years prior to termination.

In fact, less than 20 percent of participants are in plans that pay a variable-rate

premium.

The administration proposal would charge risk-based premiums to every plan

with unfunded target liabilities without exception. We believe that this will provide

a powerful incentive for plan sponsors to fund at or above their plan targets. Linking premiums to funding targets also means that the proposal will introduce the

risk of plan termination into the insurance system’s premium structure for the first

time. Revenue from both the risk-based and flat-rate premiums will be used to retire PBGC’s current deficit over an extended period of time and to pay expected future claims.

Question: Looking at a the bigger picture, I see the private sector moving away

from defined benefit plans and toward defined contribution plans. I have two questions for you. First, do you see the changes proposed by the administration as having the power to revitalize the DB sector so that new plans would be adopted, or

are we facing a dying breed no matter what we do to change the rules?

Answer: The administration believes that defined benefit pension plans should remain an option for those firms that wish to provide guaranteed retirement benefits

to their employees. In our view, the current pension funding system will not be sustainable in the long run. The administration’s proposal would revitalize the system

by placing both the pension insurance program and individual pension plans on

sound financial footing.

Under the current system, there are significant disincentives for new employers

to create defined benefit plans, such as the substantial deficit of the sponsor-financed insurance fund. Prospective defined benefit sponsors are also aware that the

current complex system of funding rules allows some sponsors to transfer the risks

of their funding and investment decisions to that same insurance system. We believe that these considerations—risk transfers and administrative complexities—also

make defined benefit plans unattractive to prospective plan sponsors.

The administration’s proposal will correct these flaws. Tightening funding rules

and returning the pension insurance program to financial health will make defined

benefit plans more attractive to employers who are now outside the system.

The administration also believes that Congress should act promptly to clarify the

legal status of cash balance and other hybrid pension plans. The only new defined

benefit plans created in recent years have been alternative benefit structures, such

as cash balance or pension equity plans that are designed to meet the needs of a

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* Cooper v. IBM Personal Pension Plan, 274 F. Supp. 2d 1010 (S.D. Ill. 2003) (holding that

cash balance plans violate age discrimination provisions of ERISA). Other courts, however, have

disagreed. Tootle v. ARINC, Inc., 222 F.R.D. 88 (D. Md. 2004); Eaton v. Onan Corp., 117 F.

Supp. 2d 812 (S.D. Ind. 2000).

younger, more mobile workforce. Unfortunately, as a result of a single Federal court

decision, the legal status of these types of plans is in question.*

Question: Second, many experts believe that hybrid pension plans may be the key

to a vibrant future for defined benefit plans, yet hybrids seem to be stymied by legal

problems. Do you think that addressing hybrid plans is as urgent as dealing with

DB plans this year?

Answer: Addressing the current crisis in funding of single-employer defined benefit plans and removing uncertainty about the basic legality of cash balance plans

are both critical to preserving the vitality of the defined benefit system, which provides retirement income security for millions of American workers and their families.

We have a legislative proposal in our budget relating to cash balance and other

hybrid plans which would not only protect the defined benefit system by clarifying

the status of cash balance plans, but also ensure fairness for older workers in cash

balance conversions and remove the effective ceiling on interest credits in cash balance plans.

RESPONSES TO QUESTIONS FROM SENATOR ROCKEFELLER

Question: I am very concerned with some of the administration’s suggestions for

limiting benefit increases and accruals. It seems to me that these changes would

punish workers in cases where company management fails to invest enough money

in the pension plan.

The administration has claimed that these benefit restrictions would prompt

workers to put pressure on employers to better fund pension plans. However, it is

not clear to me how workers could effectively stop employers from under-funding

plans.

I would like to hear how you expect workers to protect themselves, and please

specifically address how they could do so between contract negotiations as their benefits are being cut.

I would also like to know what would prevent an employer from purposely underfunding the pension plan in order to deprive workers of hard-won pension benefit

increases?

Answer: The administration believes that we must ensure that companies make

only benefit promises they can afford, and keep the promises already made by appropriately funding their pension plans. When companies are unable to keep their

pension promises, the losses are shifted to the pension insurance system and to

workers. It is these empty promises that harm workers by putting their retirement

security at risk. The new stronger minimum funding rules combined with the proposed limitations will prevent companies from making hollow promises.

The stronger minimum funding rules will prevent employers from purposely

under-funding their pension plans. Companies will be required to fund their plans

up to a meaningful funding target. Companies that fall below the minimum funding

target will be required to fund up to the target within a reasonable period of time.

A plan sponsor that is operating outside of bankruptcy cannot ignore its funding obligations without serious consequences. There are significant enforcement measures

available to the IRS and the PBGC to prevent firms from ignoring funding obligations.

The proposed benefit limitations will apply only when a plan’s funded status falls

below acceptable levels. The limit on benefit increases for certain under-funded

plans will prevent companies from promising additional benefits unless promises already made to workers are adequately funded. The limit on accruals will apply only

for plans with severe funding shortfalls or sponsors in bankruptcy with under-funded plans. The limitations will not affect benefits already earned. Rather than deprive workers of hard-won pension benefit increases, we believe that these proposals

create a strong incentive for employers to adequately fund their plans—making it

more likely that workers’ retirement expectations will be met. Our proposal takes

into account existing collective bargaining agreements by not applying these benefit

limitations until the earlier of the end of the contract term or 2009.

Plans that become subject to any of the benefit limitations will be required to notify affected workers, making them aware that deteriorating funding is threatening

their benefits. Workers need this information so that they can have realistic expectations about their company’s ability to fund pension promises. We also believe that

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in some instances, companies will improve the funding of their plans in order to

avoid notifying workers and thereby creating worker dissatisfaction.

Question: I am very concerned that the administration has made no proposal to

address the pension crisis in the airline industry. A considerable amount of the deficit facing the PBGC is expected to derive from failing airline pension plans. Yet

the administration has proposed no remedies specific to that industry that would

help airlines maintain their plans.

Some airlines have asked Congress to consider relief that would allow them to essentially restructure their pension plans. By giving the companies a longer time period to pay off debt and perhaps limiting the PBGC’s exposure to increases in pension liabilities, airlines may be able to save their pension plans.

What industry-specific relief is the administration willing to consider to protect

the pension benefits of airline employees and help the companies maintain promises

they made to their workers?

Answer: We understand the financial difficulties the airlines are facing. Congress

and the administration have provided assistance to the airlines in the form of

grants, loan guarantees, and short-term funding relief when such assistance was determined to be appropriate.

The administration’s pension reform proposal would strengthen the funding rules

to improve the health of the entire defined benefit pension system. This is particularly important for those under-funded plans that pose the greatest risk of terminating. Neither the defined benefit system nor the pension insurance system is designed to provide or capable of providing targeted relief to specific industries. It is

designed to insure benefits for participants in plans that fail.

Relaxing the funding rules for a specific industry would set a dangerous precedent

for the pension insurance program. We do not believe that the interests of participants, other premium payers, or the taxpayer are best served by allowing companies

to effectively borrow from their employees and the insurance fund to meet their financial obligations.

I would also emphasize that the majority of losses incurred by the PBGC to date

have been in industries other than airlines and that the majority of the insurance

fund exposure to ‘‘reasonably possible’’ claims is in other industry sectors. So, the

financial pressures on the pension insurance program are not unique to the airline

industry.

Current law allows plan sponsors to obtain funding waivers if they are experiencing temporary substantial business hardship. The IRS can, in consultation with

the PBGC, and often does, impose conditions on obtaining a waiver that protect the

interests of participants and the pension insurance program.

Question: I appreciate the difficulty we are facing in trying to shore up the defined

benefit pension plan system. On the one hand, we want to better protect workers

by making sure that employers are adequately funding their pension promises. On

the other hand, we want to encourage employers to continue to provide defined benefit pensions that protect workers and retirees from the risks associated with the

stock market.

I am very concerned that the administration’s proposal focuses just on addressing

the deficit faced by the PBGC. Many aspects of this proposal would increase funding

to the PBGC, but actually make it much harder for employers to maintain these

plans.

For example, the yield curve proposed by the administration would be much more

volatile and difficult for employers to predict and plan for. The yield curve also substantially increases the liability calculations for industries that have older workers.

Even healthy plans would see substantial premium increases under the administration’s reforms.

I am concerned that these are shortsighted fixes to the PBGC’s funding problems.

As defined benefit plans become more and more expensive for employers, many companies will simply shift away from offering such pensions. As healthy plans voluntarily terminate, the funding problems in the system increase, creating a vicious

cycle.

How does the administration propose to encourage companies to continue to offer

defined benefit plans?

Answer: We would respectfully disagree that the administration’s proposal focuses

just on improving the pension insurance program deficit or that it would or should

cause employers to abandon their pension plans. We believe the proposal appropriately balances competing considerations. The objective is to ensure that plan

sponsors honor the promises they have made, and the proposal requires companies

to make up their funding gap over a reasonable period of time. At the same time,

the administration’s proposal provides additional flexibility for plan sponsors and

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* Cooper v. IBM Personal Pension Plan, 274 F. Supp. 2d 1010 (S.D. Ill. 2003) (holding that

cash balance plans violate age discrimination provisions of ERISA). Other courts, however, have

disagreed. Tootle v. ARINC, Inc., 222 F.R.D. 88 (D. Md. 2004); Eaton v. Onan Corp., 117 F.

Supp. 2d 812 (S.D. Ind. 2000).

provides numerous incentives for them to maintain and prudently fund the plans

they sponsor.

For example, companies will be able to make much larger tax-deductible contributions to their plans during good economic times than under current law. Companies

that contribute more than the minimum requirement would effectively shorten the

amortization period. They would be able to reduce the amount of risk-based premium that would have to be paid. And companies would likely benefit from improved credit ratings if they reduced their unfunded pension liability, thus lowering

their cost of capital.

We also do not agree that the administration’s proposal would lead to greater volatility and make it more difficult for companies to predict their funding requirements. The risk and volatility in the pension plan is a function of the business decisions made by the company. Current law simply masks that volatility and allows

companies to shift the risks to third parties. It is because of current-law features

like smoothing and credit balances that plans sometimes are so under-funded when

they terminate. Hiding the problem doesn’t make it go away. There are numerous

ways under the administration’s proposal in which companies can minimize risk and

volatility and make funding more predictable.

The administration also believes that Congress should act promptly to clarify the

legal status of cash balance and other hybrid pension plans. The only new defined

benefit plans created in recent years have been alternative benefit structures, such

as cash balance or pension equity plans that are designed to meet the needs of a

younger, more mobile workforce. Unfortunately, as a result of a single Federal court

decision, the legal status of these types of plans is in question.*

RESPONSES TO QUESTIONS FROM SENATOR SMITH

PAYOUT OPTIONS

Question: So many of the demographic figures I have seen lately speak to the fact

that more and more of the responsibility for accumulating retirement savings is

shifting to the individual. Half of American workers get help from their employers

in the form of employer-provided savings, and half of our workers must do it on

their own. Of course we’re here discussing some of the ways to achieve further security for those who do have such access to traditional pensions and what can be done

to make them more secure.

I have actually introduced legislation that would give the same guaranteed payout

streams as traditional pensions to those who do not have access to such employerprovided plans. What the legislation provides is an incentive to consider the ‘‘delayed gratification’’ of an annuitized payout you can’t outlive when compared

against the ‘‘instant gratification’’ of receiving a simple lump sum.

The reason why I raise this issue is that even the defined benefit pension plans

we are discussing today are trending increasingly toward paying lump sums at retirement; in particular, cash balance plans. For those of us concerned that retirees

need to consider taking a guaranteed payout stream rather than just a lump sum,

what can you tell me about your plans that will create some payout options for retirees?

Answer: The administration’s funding proposal will strengthen and preserve the

defined benefit system. Preserving the system will enable more workers to have the

option of taking their pension distributions in the form of annuities. The administration’s proposal also eliminates an inappropriate incentive for participants to take

lump-sum distributions.

Under current law, the use of an inappropriately low discount rate for determining the value of lump sums creates an incentive for participants to choose lump

sums. Under our proposal, the yield curve would be used to calculate minimum

lump sums, which will eliminate this distortion that can bias a participant’s payout

decision toward lump sums. This reform includes a transition period, so that employees who are expecting to retire in the near future are not subject to an abrupt

change in the amount of their lump sums as a result of changes in law. The new

basis would not apply to distributions in 2005 and 2006 and would be phased in

for distributions in 2007 and 2008, with full implementation beginning only in 2009.

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MULTIEMPLOYER PLANS

Question: It is my understanding that the administration is not planning on taking any action on multiemployer plans in the near future. However, there is a crisis

brewing among the multiemployer plans as well. Some very large plans are close

to having to go into ‘‘reorganization,’’ and many retirees in my State of Oregon will

be impacted. Does the administration plan on reporting to us on the risk that the

multiemployer system would have to assume if some of these multiemployer plans

become insolvent?

Answer: The administration recognizes that changes in the multiemployer funding

rules are necessary. However, we focused on single-employer plans first because the

problems facing single-employer plans are more immediate and acute. Also, due to

the unique nature of multiemployer plans, not all elements of the single-employer

proposal could be immediately applied to multiemployer plans. We believe it is vitally important that Congress enact legislation to protect the retirement security of

workers in these single-employer pension plans. At the same time, however, we

must remember that there are millions of Americans who are covered by multiemployer pension plans, and that their retirement security is equally important. We

should work together in a bipartisan fashion to ensure that multiemployer plans are

strengthened.

The multiemployer insurance program covers about 9.8 million workers and retirees in about 1,600 plans. The program has only one source of funds, an annual premium payment of $2.60 per participant that generates about $24 million of income

per year.

The PBGC insurance comes into play when a multiemployer plan becomes insolvent—that is, when the plan does not have enough assets to pay benefits that fall

under the statutory limit, which was originally set at less than $6,600 per year for

a retiree with 30 years of service. In 2001, Congress amended the law to double the

limit—to $12,870 per year—but did not increase the premium. Between 1980 and

2000, relatively few multiemployer plans failed; the agency paid out $167 million

to some 33 plans.

Recently, however, more plans have failed. In its 2004 Annual Report, PBGC estimates that financial assistance payments to multiemployer plans denoted as

‘‘probables’’ will reach $30 million in 2005, $90 million in 2006, and $100 million

per year for at least a decade thereafter. In addition, it is ‘‘reasonably possible’’ that

other multiemployer plans will require future financial assistance in the amount of

$108 million in present-value terms.

The multiemployer program ran surpluses for over 20 years until it recorded its

first deficit of $261 million in FY 2003. The multiemployer program reported a deficit of $236 million in FY 2004. This is in contrast to the $23.3-billion deficit in the

single-employer program.

In the 2004 Annual Report, PBGC estimated that, as of September 30, 2004, the

total under-funding in insured multiemployer plans is more than $150 billion, compared to a 2003 estimate of more than $100 billion.

The Government Accountability Office recently completed a study that concluded

that multiemployer plans face long-term challenges, and we agree with this assessment. Because multiemployer plans are creatures of collective bargaining, the dwindling percentage of union coverage in private-sector employment has halted growth.

In addition, a substantial number of plans are concentrated in industries such as

trucking and retail foods, where employers and unions will encounter increased cost

competition from new competitors.

The PBGC is required by law to review the multiemployer plan insurance program every 5 years to assess, in a report to Congress, whether changes in the current guaranteed benefit can be supported by the existing premium structure. The

PBGC expects to complete work on the next 5-year report in late 2005.

PBGC LIABILITY

Question: In measuring its liability, the PBGC has historically used an interest

rate that is well below market rates. What would the PBGC’s deficit be using the

corporate bond interest rate that Congress enacted last year? And, what would the

PBGC deficit be using the administration’s yield curve methodology?

The administration’s proposals would require some employers to make much larger pension contributions starting right away. How much modeling has the administration done to determine how many companies would not be able to meet those

sudden increases in cash flow demand? How certain are you that we will not see

more bankruptcies as a direct result of this proposal and that you will only be turning some of those ‘‘probables’’ into ‘‘definite problems’’ for the PBGC?

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Answer: Actually, the PBGC does use market prices for valuing its liabilities both

on its financial statements and for our claims in bankruptcy. The PBGC conducts

surveys of the prices charged by private-sector insurance companies to write group

annuity contracts and derives an interest factor from those prices that, with PBGC’s

mortality table, will match the prices. The rationale for this approach is that it

maintains a ‘‘level playing field’’ between plans that terminate with PBGC and

plans that terminate in the private sector. Put another way, if a plan sponsor determined to terminate its plan (which would have to be fully funded) and annuitize

the benefits to its employees, a private-sector annuity provider would value those

liabilities the same way that PBGC does.

Using an interest factor based on prices for annuities charged by private-sector

insurance companies, the PBGC’s single-employer deficit was $23.3 billion. If PBGC

had valued liabilities using 100 percent of the spot corporate bond rate that is currently used for determining PBGC premiums, the deficit would have been about $18

billion. (Pursuant to legislation enacted by Congress last year, the corporate bond

rate is used differently for different purposes: (1) a 4-year weighted average is used

to determine plan funding, and (2) a spot rate is used to determine PBGC premiums.) If, instead, the PBGC had valued liabilities using the administration’s yield

curve methodology, the deficit would have been about $19 billion. Both estimates

assume that PBGC would continue to include in liability estimates the present

value of its own future expenses as it does under current procedures. It is also important to note that while the single-employer deficit would be lower using these

approaches, there still would have been a dramatic swing in the corporation’s financial position from a surplus to a very large deficit over the past 3 years.

We have modeled the proposal in the aggregate for the entire defined benefit system. The data indicate that the funded status of both healthy ongoing and at-risk

plans improves over time under the administration’s proposal, which is the core objective of reform. We should not lose sight of the fact that the current funding rules

don’t work and have allowed the huge funding gap to develop and grow. Absent the

kind of fundamental changes in the administration’s proposal, there is a significant

risk that the level of under-funding in terminated plans will get much larger. We

do not have the information needed to evaluate the financial impact of the proposal

on particular plan sponsors. We believe that the funding rules should apply to all

plan sponsors, and it would be inappropriate to create special rules for a particular

industry or company.

Various underlying business factors apart from pension funding lead to corporate

bankruptcies. That will continue to be the case in the future. If we make no changes

in the funding rules or further relax them, plans of bankrupt firms will be more

under-funded, participants will lose more benefits, and the taxpayer will be put at

greater risk.

It is in everyone’s best interest to keep well-funded plans in the defined benefit

system. At the same time, as we have seen, plan under-funding is destabilizing to

the system. These concerns are fairly and effectively addressed by the administration’s proposal, which would require funding of benefit promises over a reasonable

period of time.

RESPONSES TO QUESTIONS FROM SENATOR SNOWE

Question: With respect to the administration’s proposal to require plan sponsors

to use a yield curve for purposes of calculating their funding obligations, how much

modeling has it done to determine how many companies would not be able to meet

those sudden increases in cash flow demand?

Answer: The administration proposal was designed to address problems in the single-employer defined benefit system as a whole. We did not model the effects on individual firms or industries.

The modeling indicates that the funded status of both healthy ongoing and at-risk

plans improves over time under the administration’s proposal, which is the core objective of reform. Our current modeling does not include the information needed to

evaluate the financial impact of the proposal on particular plan sponsors.

With respect to your concern about sudden increases in cash flow demand, it is

important to bear in mind that the proposal includes a 3-year transition period to

the yield curve and extends amortization periods for many under-funded plans from

as little as 4 years (under the deficit reduction contribution) to 7 years.

Question: Assuming again the implementation of a yield curve, is the administration concerned that this change might actually lead to certain employers that have

currently a defined benefit plan shutting it down and dumping the responsibility

onto the PBGC?

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Answer: The yield curve provision is designed to measure liabilities by matching

current market interest rates for obligations of the appropriate maturity to the time

structure of a pension plan’s projected cash flows. We believe that this is the most

accurate way to measure plan liabilities. The administration recommends use of the

yield curve so that pension sponsors recognize the real costs of operating defined

benefit pension plans.

Only when such costs are recognized can sponsoring firms make responsible business decisions about how to design their retirement plans. Intentionally understating plan costs by mismeasuring liabilities creates future financial problems for

plan sponsors, workers, and retirees.

Question: My next question on the yield curve goes to the efficiency with which

plan sponsors will implement this sudden change. Specifically, how do you respond

to critics who contend a yield curve approach will be overly complex and create costprohibitive barriers for plan sponsors?

Answer: As I explain in my written testimony, implementing the yield curve is

not complex. A simple numeric example is included in that written testimony demonstrating how the yield curve can be used in computing pension liabilities.

We have seen no evidence that implementation of the yield curve will pose a difficult technical challenge for actuaries or that it will cause significant increases in

pension plan administrative expenses.

Question: Finally, I am not sure that a yield curve approach will do an adequate

job of ‘‘smoothing over’’ a company’s ultimate plan funding. Specifically, one of the

administration’s proposals is to permit companies to contribute extra money into

their plan above their required contribution without being penalized and while still

being entitled to an income-tax deduction. The logic here is that it will allow companies to over-fund their plans during good economic times so that they can better

weather the storm during less prosperous times. However, that logic seems to break

down if we adopt a yield curve. Specifically, the interest rates under a yield curve

approach are not averaged over a specified period of time. Without a weighted average, pension liabilities will be much more volatile from year to year, making it more

challenging for companies to develop a reliable long-term financial and/or strategic

plan for their company. What is the administration’s response to this claim?

Answer: The administration takes the view that pension rules should provide plan

sponsors with the tools to manage volatility, including amortization over 7 years

and extra opportunity to pre-fund benefits in good times. The rules should encourage use of these tools as well as available financial market tools to reduce contribution volatility rather than artificially smoothing asset and liability values and distorting current economic reality. In order to encourage such behavior, assets and liabilities will be measured on a current and accurate basis under the administration’s proposal. Liabilities will be measured using a yield curve that matches appropriate market interest rates to the time structure of the pension plan’s projected

cash flows.

The administration proposal also raises the ceiling on deductible contributions.

This will allow those plan sponsors to build funding surpluses in order to reduce

contribution volatility.

PREPARED STATEMENT OF LARRY ZIMPLEMAN

Mr. Chairman and members of the committee, thank you for the opportunity to

appear before this committee. My name is Larry Zimpleman, and I am President

of Retirement and Investor Services at The Principal Financial Group. I am a member of the Society of Actuaries and the American Academy of Actuaries.

Today, I am here on behalf of the Business Roundtable, an association of CEOs

from the largest employers in the world. Principal Financial’s Chief Executive Officer, Barry Griswell, is Vice Chairman of the Business Roundtable’s Health and Retirement Taskforce. The American Benefits Council, the American Council of Life

Insurers, the ERISA Industry Committee, Financial Executives International, the

National Association of Manufacturers, and the U.S. Chamber of Commerce also

join in the themes expressed in this testimony and some of these groups will be submitting their own supplemental testimony.

Mr. Chairman, we commend you, Senator Baucus, and the other members of the

Finance Committee for tackling the critical issue of defined benefit pension reform.

Your past leadership on these and other retirement issues has led to many of the

recent improvements that have strengthened our Nation’s retirement system, and

we urge you to continue to be active in retirement issues. We want to work with

Congress and the administration to build a more robust defined benefit system.

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The best way to protect pensions for future retirees and working Americans is for

Congress to enact permanent rules that lead to a fair and stable system. The unexpected termination of the 30-year Treasury bond in 2001, and the subsequent temporary fixes to the interest rate used for pension calculations have made it impossible for employers to project future pension contributions. This uncertainty has significantly compromised employers’ ability to make new capital investments, hire

new employees, make R&D investments or take other actions that ensure the future

of U.S. business. The current fix expires at the end of this year, and it is imperative

that Congress enact a permanent interest rate as soon as possible. In addition, uncertainty regarding the status of cash balance and other hybrid plans is stifling innovation and flexibility in pension plan design. Affirming the legality of these plans,

which cover more than 7 million Americans, is a necessary step to a vibrant defined

benefit system. Congress should act quickly to provide the certainty that is needed

in both of these areas.

We agree that other targeted reforms are needed as well. Pension plans must be

appropriately funded. Pension promises that are made are promises that must be

kept because the retirement security of millions of Americans is dependent on those

promises. Employers should not be able to make pension promises they should reasonably know they cannot keep. These practices pose a threat to participants and

to the Pension Benefit Guaranty Corporation (the ‘‘PBGC’’). But strengthening the

PBGC should not happen at the expense of the defined benefit plan system or the

economy. This testimony sets out some of the reforms that we believe should be

made and details our concerns about other reform proposals.

First and foremost, any reform proposal should be measured by the benefits or

consequences for the U.S. economy. It is in no one’s interest for pension reform to

disrupt our economy or the capital markets, since a strong economy benefits workers, retirees, plans, employers and the PBGC. Ill-conceived changes in pension rules

could drive employers out of the defined benefit system, eroding the retirement security of American workers. In the worst case, excessive changes could tip some employers into bankruptcy—costing those workers not only retirement savings but potentially their jobs. We owe it to those Americans and their families to ensure that

changes, no matter how well-intentioned, are not counter-productive.

PRINCIPLES FOR REFORM

We believe that reform in the defined benefit system should be based on the following principles:

• Ensure the continued success of the defined benefit pension system. The pension

system benefits millions of Americans, with over 34 million participants currently relying on single-employer defined benefit pension plans as a critical element of their retirement security. Reforms, no matter how well-intentioned,

should not drive employers out of the system.

• Avoid disrupting or undermining the economy. Nearly $2 trillion is held by private-sector pension plans, and the pension system accounts for 6 percent of all

U.S. equity investments. It is essential that any reforms avoid abrupt and unnecessary disruption to the U.S. economy.

• Protect employer flexibility. To compete effectively and attract and keep skilled

workers, employers must be able to tailor pension plans to the unique needs of

their workers and the competitive environment in which they function. The

flexibility to utilize varied pension plan designs, including cash balance and

other hybrid plans, is imperative if we are to maintain a vital defined benefit

system.

• Provide predictability in future pension costs. Pension policy must provide employers with the certainty that will allow them to make new capital investments, to hire new employees, and to make R&D investments.

• Preserve rules that minimize funding volatility. It is essential that any reforms

reflect the long-term nature of pension promises and smooth liability and asset

valuations. Volatility in these calculations makes it impossible for employers to

plan and make prudent business decisions, slowing the economy. Volatile pension funding rules can also exaggerate economic cycles, leading to deeper recessions and greater job loss during down times.

• Advance rules that promote pension plan funding. The pension system should

encourage employers to make contributions to their plans as early as possible

and ensure there is no disincentive to fund plans in advance of future liabilities.

We strongly support the proposals like those previously approved by this committee to revise the tax deduction rules that prevent employers from contributing to defined benefit plans during good economic times.

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• Provide timely and appropriate information to participants. Participants should

have the information they need to evaluate their retirement security. Existing

funding disclosure requirements should be enhanced to provide timely and useful information about retirement plans, while at the same time avoiding the creation of costly, confusing or misleading new requirements. • Minimize the moral hazard in the pension system. Plan sponsors that make pension promises they cannot keep only to ‘‘shift’’ their liabilities to the PBGC pose

a hazard to other sponsors participating in the system. Careful consideration

should be given to reforms that prevent benefit increases that are not likely to

be funded within a reasonable period of time.

KEY ISSUES

A few weeks ago, Secretary of Labor Chao and PBGC Director Belt released a

broad package of proposals that would completely change the funding rules applicable to single-employer defined benefit plans. There are a number of themes in the

administration’s proposals that are consistent with the reform principles we recommend. For example, the administration’s focus on better disclosure to plan participants is a goal we share. Similarly, proposals to change the tax rules to allow

employers to make larger contributions during good economic times are long overdue.

On the other hand, some of the reform proposals represent an unnecessary wholesale departure from the existing rules. Starting from scratch exacerbates the risks.

Most of the reform proposals were presented for the first time in the FY 2006 Budget Proposal. Without understanding the impact of the proposals as a whole, the

damage to the system and our economy could be substantial. The following provides

a more detailed analysis of certain key issues that are raised by the administration’s

proposals.

Making the long-term corporate bond rate permanent

In our view, the need to permanently replace the obsolete 30-year Treasury bond

rate used for pension calculations is the most pressing issue facing employers that

sponsor, and individuals who rely on, defined benefit pension plans. Without a permanent interest rate fix, employers cannot project their pension costs beyond 2005

and make informed business decisions. Today, a long-term corporate bond rate averaged over 4 years is used on an interim basis to determine ‘‘current liability’’ for

the funding and deduction rules and to determine unfunded vested benefits for purposes of PBGC variable-rate premiums. However, the measurement rate defaults to

the rate on the now defunct 30-year Treasury bond beginning in 2006 if no further

action is taken. It is widely agreed that the 30-year Treasury bond is no longer a

realistic measure of future liabilities and would inappropriately inflate pension contributions and PBGC variable-rate premiums, especially during times of historically

low interest rates similar to the interest rate conditions we are experiencing today.

A return to an inappropriate and inaccurate measure of pension liabilities and the

resulting inflated contributions caused by the defunct 30-year Treasury bond rate

would be devastating for the ongoing vitality of the defined benefit system and

would be enormously disruptive for employers and the strength of the economy.

We believe the best way to protect the pension system for future retirees is to

make permanent the long-term corporate bond rate that Congress adopted last year.

As Congress has recognized, the long-term corporate bond rate provides a realistic

picture of future pension liabilities and is the best measure to ensure the adequacy

of pension funds for future retirees. The long-term corporate bond rate reflects a

very conservative estimate of the rate of return a plan can be expected to earn and

thus is an economically sound and realistic discount rate. Plans generally invest in

a diversified mix of equities and bonds. For long-term obligations, plans generally

invest in equities because equities have historically earned a greater rate of return

than bonds. For mid-term liabilities, plans generally invest in a mix of equities and

bonds and, for short-term liabilities, plans invest more in short-duration bonds. The

net effect is that plan’s have historically earned higher rates of return than even

the rate of return on long-term corporate bonds. For this reason, the long-term corporate bond rate is a very conservative measure of liability.

We also believe that the interest rate used for determining the amount of lumpsum distributions should be conformed to the interest rate used for determining liabilities. Under current law, lump sums cannot be less than the amount determined

using the defunct 30-year Treasury bond rate. This artificially inflates lump sums,

which has contributed to funding pressures, and we support using the long-term corporate bond rate to determine lump-sum payments.

It is important that the permanent interest rate that is chosen for funding and

lump-sum purposes be a fair and stable rate. We appreciate that the administration

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has stepped forward with a proposal that recognizes the need for permanent replacement of the obsolete 30-year Treasury bond rate. However, we remain deeply

concerned that the yield curve aspect of the proposal could produce an effective interest rate that is too low and therefore will overstate liability. Relative to the

weighted long-term corporate bond rate in effect this year, the administration’s proposal could increase pension liabilities for a typical mature plan by 10 percent or

more. In some cases, the immediate liability increase could be even greater. For

large plans, this could cost billions of dollars. These dollars are far in excess of what

is needed to provide a high degree of certainty that plans have enough to pay benefits. Moreover, the shape of the yield curve itself, as it steepens and flattens over

time, could have a dramatic impact on mature plans.

The consequences of excessive contribution obligations are painfully clear. This is

precisely what happened when inflated pension contributions were mandated by the

obsolete 30-year Treasury bond rate. Employers that confront inflated contribution

obligations will have little choice but to stop the financial bleeding by freezing or

terminating their plans. Both terminations and freezes have truly unfortunate consequences for workers—current employees typically earn no additional pension accruals and new hires will not have a defined benefit plan whatsoever. Government

data reveals that defined benefit plan terminations accelerated prior to the temporary long-term corporate bond rate fix in the Pension Funding Equity Act of 2004,

with a 19-percent drop in the number of plans insured by the PBGC from 1999 to

2002. Just as troublesome, the statistics above do not reflect plans that have been

frozen. While the government does not track plan freezes, reports make clear that

these freezes were on the upswing.

Inflated pension contributions also divert precious resources from investments

that create jobs and contribute to economic growth. Facing pension contributions

many times greater than they had anticipated, employers will not hire new workers,

invest in job training, build new plants, and pursue new research and development.

These are precisely the steps that would help lower our Nation’s unemployment

rate, spur individual and corporate spending, and generate robust economic growth.

There are also questions about whether the interest rate changes proposed by the

administration can stand the test of time. Current law requires employers to make

contributions equal to the greater of contributions required under the deficit reduction contribution rules (the ‘‘DRC rules’’) or the ERISA funding rules. The proposal

would eliminate the ERISA funding rules and replace the current system with a single-tiered system modeled on the DRC rules. The ERISA funding rules play an important role because they reflect that for liabilities that span many years, providing

a specific value on a specific day has little meaning in today’s volatile market environment. Because the ERISA rules use a long-term interest rate to value liabilities,

the ERISA rules remain an appropriate measure of liability for many defined benefit plans. The proposal to eliminate the ERISA funding rules could lead to serious

under-funding in a high interest rate environment.

Moreover, even with the proposed increase in permissible deductible contributions, employers would be prohibited from adequately funding their plans in high

interest rate periods—contributions that would be permitted under today’s rules. As

we have modeled the yield curve proposal, there are significant periods over the last

few decades in which contributions would not have been possible. For example, during the early 1980s when many companies made significant contributions to their

plans, the administration’s interest-rate proposal would have barred many of these

companies from contributing.

Finally, we would note that the Treasury’s yield curve methodology would also

add complexity to an already overburdened system. The proposal would generate a

series of interest rates for each participant. This level of complexity may be manageable by large employers, particularly sophisticated financial employers. However, it

would impose a substantial burden on small and mid-sized employers, and even

large employers that do not utilize a yield curve in their day-to-day operations. We

also note that there are a myriad of questions about the construction and composition of the yield curve. The proposal is intended to reflect the market. However, the

markets for corporate bonds of many durations are so thin that the interest rates

used would need to be created internally by the Treasury Department. More generally, we are concerned that the interest rate constructed by the Treasury Department would be opaque and that it would be virtually impossible for employers to

model it internally as part of corporate planning. This type of an interest rate would

also be particularly difficult for Congress to oversee.

Preserving rules that make pension funding predictable

Predictable funding rules are important because they allow employers to make

long-term financial plans. Future pension costs can represent significant investVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00116 Fmt 6601 Sfmt 6621 23367.000 SFINANC2 PsN: SFINANC2
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* Results of a study prepared by Robert F. Wescott, PhD. Dr. Wescott is an economist who

works on macroeconomic, financial, and pension savings issues. Dr. Wescott served as Chief

Economist at the Council of Economic Advisers and as Special Assistant to the President for

Economic Policy. The study was reviewed by Professor Deborah J. Lucas, Household International Professor of Finance, Department of Finance, J.L. Kellogg Graduate School of Management, Northwestern University, and Professor Stephen Zeldes, Benjamin Rosen Professor of Economics and Finance at Columbia University’s Graduate School of Business, and chair of the

school’s Economics Subdivision.

** The INFORUM Model, developed and maintained by economists at the University of Maryland, is one of the leading econometric models of the U.S. economy. The INFORUM Model is

highly regarded for its simulation properties and its ability to capture the likely economic impacts of policy changes.

ments—more than $1 billion per year for some employers. Financial decisions of this

magnitude require planning and substantial lead time. This can only occur with predictable funding rules.

We are concerned that the administration’s proposal will dramatically increase

the already volatile and unpredictable funding rules by moving to a spot valuation

of liabilities based on interest rates for the preceding 90 business days. In contrast,

under current law, pension liability is valued using a weighted average of interest

rates for the preceding 4 years. The use of a spot rate to value liability is one of

a number of features of the administration’s proposal that would move plans towards mark-to-market measurement, including, for example, the proposed elimination of actuarial valuations of assets and proposed imposition of PBGC variablerate premium obligations any time a plan is less than 100-percent funded on a spot

basis.

As a threshold matter, it is critical to recognize that spot valuations do not mean

tougher funding standards. Total funding remains the same; the spot or smoothed

rate only affects when contributions are due and the degree of volatility associated

with those contributions. As interest rates rise, a spot rate will result in smaller

contributions and vice versa. Over the long-term, contributions are the same. Further, spot valuations are neither accurate nor meaningful for pension liabilities that

span many years. A spot interest rate for 90 days is not a particularly accurate

measure of liabilities that in many cases span more than 40 years.

As we have begun to model the administration’s proposals based on information

provided to date, declines in funded status of 10 percent or more from year to year

would not appear to be out of the ordinary. For most employers, such a swing would

mean a dramatic increase in funding, regardless of any amortization of the shortfall.

The pension funding rules are already unpredictable and volatile, and many sponsors have opted out of the system because of this lack of predictability. Surveys suggest that employers view this as the top impediment to maintaining a defined benefit plan. For this reason, we are concerned that the spot rate proposal could have

disastrous consequences for the ongoing vitality of the system.

We are also concerned that the proposed use of a spot rate could have very negative implications for the U.S. economy. Spot valuations require larger contributions

during economic downturns and smaller contributions during economic upturns.

Larger contributions reduce capital spending. This exaggerates downturns and upturns. The result is that the economy overheats during upturns and has deeper recessions during downturns. In economic terms, spot valuations have a ‘‘procyclical’’

effect on the economy. Research done at the request of the Business Roundtable indicates that the use of the spot rate relative to current law would have significantly

exaggerated the most recent economic downturn.* For example, econometric modeling ** suggests that a spot rate would have cost the economy more than 300,000

jobs during 2003. This would not have meant improved funding over the long haul,

only exaggerated economic cycles and job losses.

Some have suggested that defined benefit plans can manage the lack of predictability in a spot rate proposal by investing in bonds and financial derivatives that

hedge against interest rate movements. Hedging can be very expensive, and plans

should not be effectively forced to incur this cost. For many defined benefit plans,

their investment policy committee does not allow the use of any form of derivatives.

Even for plans that want to hedge, it is far from clear that there ever could be

enough bonds or other instruments to permit plans to hedge their liability against

interest rate movements. For example, hedging in bonds would require using the

particular class of bonds that compromise the relevant interest rate benchmark. The

administration’s interest rate is comprised solely of AA bonds, and it is doubtful

that there would ever be a deep enough market in this particular class for many

plans to effectively hedge. Further, there are a limited number of derivatives

issuers, and a significant movement towards derivatives would concentrate risk

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trating risk within a limited number of counter-parties needs to be carefully considered before any fundamental change of this type is considered. Moreover, it is simply not possible to truly immunize, because pension liabilities that depend on life

expectancy cannot be hedged with bond portfolios. While this may be less of an issue

for very large plans with large pools of participants, it would be a very significant

problem for small and mid-sized plans. Since retirement plan liabilities depend in

part on business prospects affecting when individuals retire, including elections of

early retirement subsidies, it is impossible to precisely calculate the duration of plan

liabilities.

More importantly, if a fundamental change in the pension funding rules should

force a movement of pension funds out of equities and into bonds or other low-yielding instruments, it could have a marked effect on the stock market, the capital markets, and capital formation generally. These effects need to be carefully considered

because the consequences could be staggering. The volume of defined benefit plan

assets held in equities is substantial. At the end of 2003, private-sector defined benefit plans held equities worth about $900 billion, compared with total U.S. equity

capitalization of about $15 trillion. This represents more than 6 percent of equity

market capitalization. There is no historical experience with a portfolio shift of this

magnitude to serve as a guide, and the market impact is extremely difficult to predict. In general, an effectively forced sale of equities into bonds would work in the

direction of depressing stock prices and raising bond prices. Higher bond prices

would push down yields, further compounding the funding pressure, because lower

stock prices would depress asset valuations and lower bond yields would increase

plan liabilities.

Eliminating barriers to pre-funding

One aspect of the administration’s proposal that we strongly support is the proposal to reform the tax rules governing the deductibility of pension plan contributions. We are pleased that this committee has previously approved improvements

in the deduction rules. Existing tax rules that prevent employers from making pension contributions at appropriate times during the business cycle must be eliminated. Employers need to be able to fund up their plans when they have the capacity to do so.

We support increasing the deduction limit to 130 percent of liability. Equally important, we note that the combined plan limit on deductible contributions, which

limits the deductions for an employer who maintains both a defined benefit and a

defined contribution plan, needs to be adjusted. Otherwise, the current 25 percent

of compensation rule will inappropriately limit deductible contributions for plans

with large retiree populations relative to the current working population. In addition, we strongly recommend repealing the excise tax on nondeductible contributions. Finally, we recommend providing employers with flexibility in timing the year

in which deductions are claimed. Under present law, pension contributions can be

deductible in the year of contribution or, in the case of contributions made before

the due date for the prior year’s return (including extensions), the prior year. This

inflexible rule can prevent adequate funding. For example, an employer with expiring foreign tax credits may have little choice economically but to defer pension contributions for a year, in order to keep its taxable income high, which is a bad policy

result. By allowing corporations greater flexibility on when to deduct, they will be

more likely to contribute when they can and will be less worried about corporate

tax capacity.

Encouraging advance funding

We are also concerned about elements of the administration’s funding proposal

that could discourage employers from contributing more than the minimum required

contribution. Under current law, if a company makes a contribution in excess of the

minimum required contribution, the excess plus interest can be credited against future required contributions. This credit for pre-funding helps to mitigate volatile

and unpredictable funding requirements by allowing and encouraging a sponsor to

fund up during good times. The proposal, however, does not give employers who prefund direct credit for their excess contributions.

There have been suggestions that the current-law credit balance system has been

a factor in terminating plans assumed by the PBGC. These suggestions ignore the

fact that, but for the credit balance system, companies would have contributed less,

resulting in more under-funding and more liabilities assumed by the PBGC. Critics

have also pointed out that credit balances are not immediately adjusted if the underlying value of the assets decreases. Consequently, plans with poor investment results have been able to use credit balances that no longer exist to meet their minimum required contributions. We support carefully targeted reforms that address

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this investment result problem. These reforms must be administrable and need to

be applied prospectively. It would be fundamentally unfair to change the rules retroactively for employers that made contributions in reliance on current-law credit balance rules. It is critical, however, that we preserve appropriate incentives to advance-fund. Without these incentives, there is a significant risk that employers will

only pre-fund to the minimum required by law. The result would be a less wellfunded system, which is in no one’s interest.

Avoiding unnecessary bankruptcies

Another issue that has been raised is whether it is prudent or feasible to base

a retirement plan’s rules on the determination of the creditworthiness of the plan

sponsor and the members of the sponsor’s controlled group. The PBGC has proposed

basing funding, PBGC premiums, and the benefits a participant can receive on credit ratings. In effect, the employer’s liability is treated as increasing when the employer’s credit rating slips, even though the plan’s benefit payment obligations remain unchanged.

The use of credit ratings to determine funding or PBGC premium obligations

could have significant macroeconomic effects. Such use would put severe additional

pressures on employers experiencing a downturn in their business cycle. If the lower

credit ratings create additional funding burdens and business pressures, that could

lead to further downgradings, creating a vicious circle that drags a company down.

This could well happen to a company that today is able to fund additional contributions to pull itself out of the under-funding problem and thus raise its credit ratings.

In short, a creditworthiness test would make it more difficult for a struggling company to recover. That is not in anyone’s interest, including the PBGC, which could

be forced to assume plan liabilities if the company does not recover. We must be

careful not to lose sight of the fact that the best insurance for plans, participants

and beneficiaries, and for the PBGC is a healthy plan sponsor.

It is also clear that the PBGC’s proposal would classify many plans as at risk that

will never be terminated. The mere fact that a company’s debt is not rated as investment-grade does not mean that it will terminate its plans. However, the consequence of these ‘‘false positives’’ could well be self-fulfilling, with employers forced

to terminate as a result of a downward spiral. Moreover, employers that have noninvestment-grade debt but are improving their situation would get no credit for such

improvement.

In addition, there are only a handful of credit rating entities, and we are also concerned that a creditworthiness test would inappropriately vest these entities with

enormous power. This is particularly troubling at a time when the credit rating

agencies, and the credit rating process itself, have been the subject of significant

criticism. These criticisms have raised questions about the credibility and reliability

of credit ratings. In this context, a creditworthiness test is ill-conceived.

Finally, we also note that a creditworthiness test would inevitably result in the

government determining the creditworthiness of at least some American businesses.

Many privately held employers are not rated by any of the nationally recognized

agencies, and the PBGC has recommended conferring regulatory authority to develop guidelines for rating private companies. This would be unprecedented.

It is also important to recognize that an employer’s credit rating is not directly

tied to the plan’s ability to provide the promised benefits. The plan is a separate

entity, and one of the hallmarks of U.S. pension law is that pension assets must

be held in a separate trust or similar dedicated vehicle. A plan that has assets sufficient to pay benefits will pay those benefits even if the plan sponsor does not have

adequate assets to pay its debts or otherwise has debt that is rated below investment grade.

Providing timely and appropriate disclosure

We believe that participants should have timely and high-quality data regarding

the funded status of their plans. It is important that participants have the information they need to evaluate their retirement security. These rules should be structured to provide full and fair disclosure without creating undue administrative burdens on plans or causing unnecessary concerns among participants.

In this context, existing disclosure requirements should be enhanced, while at the

same time avoiding the creation of costly and confusing new requirements. Such an

approach avoids the significant burdens of providing new documents to participants.

A starting point might be the administration’s general proposal to improve the summary annual report (‘‘SAR’’), but with significant modifications that would make the

information disclosed more immediate and more meaningful. One of the problems

with the SAR under current law is that the information disclosed is not timely, a

problem which is not addressed by the administration’s proposal. In fact, currently,

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the information provided can be almost 2 years old. Accordingly, we would propose

stronger changes.

All plans could be required to disclose in the SAR their funded percentage on a

current liability basis. However, instead of reporting percentages as of the first day

of the plan year for which the SAR is provided, the percentage could be reported

as of the first day of the following year, using (1) the fair market value of assets

as of that date and (2) the liabilities as of that date based on a projection from the

preceding year. A plan maintained by a public company could also be required to

disclose the year-end funded status of the plan as determined for purposes of financial accounting for the 2 most recent years available.

This approach would provide much more information than under present law or

under the administration’s proposal. Information would also be based on the fair

market value of plan assets, as well as a timely current interest rate in the case

of financial accounting information. In addition, unlike the administration’s proposal, financial accounting information that is already circulated and disclosed could

be used. By using information available to employees through financial reports and

media statements, the possibilities for confusion would be greatly reduced.

Funding the PBGC appropriately

The PBGC has openly stated that premium increases are in large part needed to

fill the PBGC’s deficit. While we fully agree that the PBGC has a significant deficit,

the $23 billion figure overstates the problem, and the required premium increases

are, at best, premature and excessive. In addition to the fact that we continue to

be in a period of historic low interest rates—rates that temporarily inflate PBGC’s

liability—, the PBGC uses an even lower interest rate (roughly 4.8 percent) to value

its liability, thereby overstating its liability as well as ignoring possible future

PBGC investment gains.

While we believe that reform is needed to address the growing deficits at the

PBGC, we feel that the best way to deal with that problem is to keep more employers in the system, not to tax them out of the system. The PBGC proposes unprecedented increases in premiums, including a 60-percent increase in the flat-rate premium, plus guaranteed future flat-rate premium increases and effective increases

in variable-rate premiums, which many more plans would have to pay given the

much larger definition of liability.

These massive premium increases would put a huge strain on plans. The PBGC’s

unprecedented proposal to index the flat-rate premium for wage inflation, guarantees ever-escalating PBGC premiums for all employers, even if the agency does not

require the funds. In addition, the PBGC’s unprecedented proposal to allow its

board to set variable premiums would make it impossible for plan sponsors to predict premiums from year to year. Rising and uncertain premiums will force many

plan sponsors, including especially small employers, to exit the system.

Confirming the legality of hybrid plan designs

Hybrid defined benefit pension plans, such as cash balance and pension equity

plans, were developed to meet the needs of today’s mobile workforce by combining

the best features of traditional defined benefit plans and defined contribution plans.

Nearly a third of large employers with defined benefit plans maintain hybrids, and,

according to the PBGC, there are more than 1,200 of these plans providing benefits

to more than 7 million Americans as of the year 2000. These plans are defined benefit plans, and many of the same funding issues described above are relevant. They

also face unique issues.

Despite the significant value that hybrid plans deliver to employees, current legal

uncertainties threaten their continued existence. As a result of one court decision,

every employer that today sponsors a hybrid plan finds itself in potential legal jeopardy. It is critical that this uncertainty be remedied, and pension reform legislation

needs to clarify that the cash balance and pension equity designs satisfy current age

discrimination and other related ERISA rules. In addition to clarifying the age-appropriateness of the hybrid plan designs, we believe it is essential to provide legal

certainty for the hybrid plan conversions that have already taken place. These conversions were pursued in good faith and in reliance on the legal authorities in place

at the time.

Some in Congress are seeking to impose specific benefit mandates when employers convert to hybrid pension plans. For example, some would require that employers pay retiring employees the greater of the benefits under the prior traditional or

new hybrid plan. Others would require employers to provide employees the choice

at the time of conversion between staying in the prior traditional plan or moving

to the new hybrid plan. We strongly urge you to reject such mandates. Inflexible

mandates will only drive employers from the system and reduce the competitiveness

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of American business. Employers must be permitted to adapt to changing business

circumstances while continuing to maintain defined benefit plans.

CONCLUSION

In evaluating any change, the interests of tens of millions of American workers

and retirees who rely on the private pension system as a critical element of their

retirement security must remain paramount. Two badly needed changes must be enacted quickly to preserve that system. The first is the permanent adoption of the

long-term corporate bond rate. The second is a rational framework for hybrid plans.

There is substantial agreement on the need for both of these changes.

Given the size of private pension plans in the U.S. economy and the value of pension plans relative to other company assets, the consequences of other pension

changes could be harmful for both the U.S. economy and American workers. Pension

reform must not disrupt economic growth critical to workers, retirees, plans, companies or the PBGC. In particular, we are concerned that certain changes could have

serious unintended macroeconomic costs.

• Spot rates exacerbate economic downturns and job losses. Proposals that move

to a spot rate to value pension liability could intensify the cyclical nature of the

U.S. economy—deepening economic downturns and increasing job losses during

recessions. A spot rate would cause pension liabilities to rise during recessions,

forcing employers to make larger contributions and cut investment spending

when the economy is at its weakest. We are very concerned that reductions in

investment spending would deepen recessions and slow job growth.

• Volatility compromises long-term business planning. Use of a spot interest rate

to value pension liability and mark-to-market treatment of assets would also

make the funding rules even more volatile and unpredictable, without improving accuracy or plan funding. This could severely handicap the ability of employers to make long-term business plans. Proposals to eliminate credit balances, which provide a cushion against unpredictable volatility, would exacerbate this problem.

• Excess contributions undermine investment and economic growth. Requiring contributions in excess of what is reasonably and realistically needed to fund promised benefits could be incredibly disruptive to the economy, draining capital that

would otherwise be used for investment and growth.

• Proposals could cause unnecessary bankruptcies. Proposals that base contributions and PBGC premiums on credit ratings would create the potential for a vicious downward corporate spiral. If lower credit ratings create additional funding burdens and business pressures, that could lead to further downgrades, creating a circle that drags a company down that would otherwise recover. We are

concerned this type of spiral could be disastrous for American workers and the

economy. Similarly, for some employers, the increased cash flow burden associated with sudden inflated contribution obligations could force unnecessary

bankruptcies, with devastating consequences for workers and our economy.

We believe that reforms are needed to strengthen the system but that reforms will

require considerably more discussion to avoid unintended results. We have outlined

a number of specific ideas above, and we urge the committee to consider them.

Mr. Chairman and members of the committee, we thank you for the opportunity

to present our views. We look forward to working with the committee and the administration on a comprehensive discussion of the long-term funding challenges facing our pension system, as well as proposals designed to provide additional protection to the PBGC.

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RESPONSES TO QUESTIONS FROM SENATOR BAUCUS

Question: You referenced a study that shows a significant loss of jobs would have

occurred in 2003 if the spot rate had been in effect instead of a current 4-year

weighted average.

Did the study distinguish between the impact of the yield curve and the increased

contribution requirements for non-investment-grade companies? If so, what was the

impact of the different components?

Answer: We have attached a copy of the study for your consideration. The study

is an ‘‘apples to apples’’ comparison of the administration’s spot rate proposal to the

current 4-year weighted averaging mechanism. It evaluates the probable economic

effects if the administration’s 90-day spot rate been in effect rather than the 4-year

weighted average rate that was in effect. To this end, the study compares contributions made using the 4-year weighted average of the 30-year Treasury bond rate

(the interest rate in effect during the relevant years) to the contributions that would

have been made had the 90-day average of the 30-year Treasury bond rate been in

effect. As a result, the effects of the yield curve and the increased contribution requirements for non-investment-grade companies are not reflected in the job loss

numbers. It is reasonable to assume that the job loss numbers would have been significantly worse had those requirements been in effect, but we have not conducted

a study on the macroeconomic effects of those requirements.

Question: Would the ability to make higher contributions in good times have affected the results of the study?

Answer: It is not clear that the administration’s proposal actually permits higher

contributions during good times. The administration’s proposal could severely restrict funding relative to current law during higher interest rate environments. In

addition, the administration has not proposed modifying or eliminating the combined plan limit restricting deductible contributions to 25 percent of compensation,

which would preclude many employers with significant retiree populations from

building a funding cushion. Similarly, the administration’s proposed elimination of

the credit balance system would discourage pre-funding. That said, if companies had

the ability to make higher contributions in good times and build a ‘‘funding cushion,’’ this cushion would have reduced the contributions required during the depths

of the economic downturn. It makes sense that this would have softened the downturn and saved jobs, but the extent of the improved job numbers would depend on

the degree to which employers in fact made higher contributions.

Question: Would the retention of the credit balance system have affected the results of the study?

Answer: The study does not take into account the effects of the current credit balance system. However, credit balances mitigate funding volatility and help employers to weather economic downturns. As a result, it seems likely that the administration’s proposed elimination of the current-law credit balance system would have resulted in greater job loss during the downturn from 2000–2003. However, we have

not attempted to quantify the role credit balances play in mitigating recessions and

keeping the economy from overheating.

RESPONSES TO QUESTIONS FROM SENATOR HATCH

Question: Mr. Zimpleman, you mentioned in your statement that any reforms accomplished this year should not drive employers out of the pension system. Do you

believe any part of the administration’s proposal would result in plans being frozen

or terminated?

Answer: We have serious concerns about many elements of the administration’s

proposal. Our primary concerns are that the proposal would (1) drastically restrict

the predictability of funding and premium obligations through spot valuations of liabilities and assets; (2) introduce a counterproductive and troubling use of credit

ratings; (3) create a strong disincentive to pre-fund through the complete elimination of credit balances; and (4) burden the defined benefit plan system with PBGC

premium increases that are not warranted. We fear that the net result would be

fewer defined benefit plans, lower benefits, and far more pressures on troubled companies that jeopardize the companies’ ability to recover.

Quesion: What is the most important single thing Congress should do this year

to keep the DB pension system viable?

Answer: The best way to protect pensions for future retirees and working Americans is for Congress to enact permanent rules that lead to a fair and stable system.

The unexpected termination of the 30-year Treasury bond in 2001, and the subsequent temporary fixes to the interest rate used for pension calculations have made

it impossible for employers to project future pension contributions. Congress should

make permanent the long-term corporate bond rate adopted last year on a temVerDate 11-MAY-2000 17:07 Sep 23, 2005 Jkt 095484 PO 00000 Frm 00130 Fmt 6601 Sfmt 6621 23367.000 SFINANC2 PsN: SFINANC2
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porary basis. The long-term corporate bond rate provides a realistic picture of future

pension liabilities and is the best measure to ensure the adequacy of pension funds

for future retirees. In addition, uncertainty regarding the status of cash balance and

other hybrid plans is stifling innovation and flexibility in pension plan design. Affirming the legality of these plans is a necessary step to a vibrant defined benefit

system.

Question: From a theoretical standpoint, is there anything deficient with the administration’s yield curve?

Answer: We have concerns about five aspects of the administration’s ‘‘yield curve’’

proposal. First, the administration’s yield curve interest rate is a ‘‘spot rate’’ rather

than a 4-year weighted average rate. It will eliminate current-law smoothing of interest rates and saddle employers with unpredictable funding obligations. Second,

the yield curve proposal would apply different interest rates to different payments

to be made by the plan based on the date on which that payment is expected to

be made. This is an unnecessarily complex methodology. Third, we are concerned

that the administration’s mechanisms for creating interest rate assumptions would

require excessive and unnecessary contributions for some mature plans, which could

be very harmful for employers, workers, and the economy. Fourth, the proposed

yield curve is opaque because it is not an interest rate that is available in the marketplace. The yield curve is constructed by the Treasury Department using as much

art as science, and it will be very difficult for businesses to use in long-term planning as well as for Congress to oversee. Finally, we are concerned that the yield

curve would improperly understate liabilities and restrict funding during higher interest rate environments. Current law requires companies to make contributions

equal to the greater of contributions required under the deficit reduction contribution rules or the ERISA funding rules. The ERISA funding rules, which the administration would repeal, ensure that companies properly fund their plans during all

economic environments.

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