Testimony 

Before the Subcommittee on Government 

Management, Finance and Accountability, 

Committee on Government Reform, 

House of Representatives 

United States Government Accountability Office

GAO 

For Release on Delivery 

Expected at 2:00 p.m. EST 

Wednesday, March 2, 2005 PENSION BENEFIT 

GUARANTY 

CORPORATION 

Structural Problems Limit 

Agency’s Ability to Protect 

Itself from Risk 

Statement of David M. Walker 

Comptroller General of the United States 

GAO-05-360T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

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www.gao.gov/cgi-bin/getrpt?GAO-05-360T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Barbara 

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Highlights of GAO-05-360T, a report to 

Subcommittee on Government 

Management, Finance, and Accountability, 

Committee on Government Reform, 

House of Representatives 

March 2, 2005

PENSION BENEFIT GUARANTY 

CORPORATION 

Structural Problems Limit Agency’s 

Ability to Protect Itself from Risk 

Existing laws governing pension funding and premiums have not protected 

PBGC from accumulating a significant long-term deficit and have exposed 

PBGC to “moral hazard” from the companies whose pension plans it insures. 

The pension funding rules, under the Employee Retirement Income Security 

Act (ERISA) and the Internal Revenue Code (IRC), were not designed to 

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

event that plan sponsors run into financial distress. Meanwhile, in the 

aggregate, premiums paid by plan sponsors under the pension insurance 

system have not adequately reflected the financial risk to which PBGC is 

exposed. Accordingly, PBGC faces moral hazard, and defined benefit plan 

sponsors, acting rationally and within the rules, have been able to turn 

significantly underfunded plans over to PBGC, thus creating PBGC’s current 

deficit. 

Despite the challenges it faces, PBGC has proactively attempted to forecast 

and mitigate its risks. The Pension Insurance Modeling System, created by 

the PBGC to forecast claim risk, has projected a high probability of future 

deficits for the agency. However, the accuracy of the projections produced 

by the model is unclear. Through its Early Warning Program, PBGC 

negotiates with companies that have underfunded pension plans and that 

engage in business transactions that could adversely affect their pensions. 

Over the years, these negotiations have directly led to billions of dollars of 

pension plan contributions and other protections by the plan sponsors. 

Moreover, PBGC has changed its investment strategy and decreased its 

equity exposure to better shield itself from market risks. However, despite 

these efforts, the agency ultimately lacks the authority, unlike other federal 

insurance programs, to effectively protect itself. 

Assets, Liabilities, and Net Financial Position of PBGC’s Single-Employer Insurance 

Program, 1980-2004 

More than 34 million workers and 

retirees in about 30,000 singleemployer defined benefit plans rely 

on a federal insurance program 

managed by the Pension Benefit 

Guaranty Corporation (PBGC) to 

protect their pension benefits. 

However, the insurance program’s 

long-term viability is in doubt and 

in July 2003 we placed the singleemployer insurance program on 

our high-risk list of agencies with 

significant vulnerabilities for the 

federal government. In fiscal year 

2004, PBGC’s single-employer 

pension insurance program 

incurred a net loss of $12.1 billion 

for fiscal year 2004, and the 

program’s accumulated deficit 

increased to $23.3 billion from 

$11.2 billion a year earlier. Further, 

PBGC estimated that underfunding 

in single-employer plans exceeded 

$450 billion as of the end of fiscal 

year 2004. 

This testimony provides GAO’s 

observations on (1) some of the 

structural problems that limit 

PBGC’s ability to protect itself 

from risk and (2) steps PBGC has 

taken to forecast and manage the 

risks that it faces. 
Page 1 GAO-05-360T 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss the underlying structural 

problems and long-term challenges facing the defined benefit pension 

system and the Pension benefit Guaranty Corporation (PBGC). Before 

addressing these matters specifically, I would like to place these 

challenges in the context of the larger challenges facing the federal 

government today, which we discuss in our recently issued 21st Century 

Challenges report.1

 There is a need to bring the federal government and its 

programs into line with 21st century realities. This challenge has many 

related pieces: addressing our nation’s large and growing long-term fiscal 

gap; deciding on the appropriate role and size of the federal government—

and how to finance that government—and bringing the panoply of federal 

activities into line with today’s world. Continuing on our current 

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

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

therefore must fundamentally reexamine major spending and tax policies 

and priorities in an effort to recapture our fiscal flexibility and ensure that 

our programs and priorities respond to emerging security, social, 

economic, and environmental changes and challenges. 

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

the role of government organizations, programs, and policies. The 

Employee Retirement Income Security Act (ERISA) was enacted in 1974 to 

respond to trends and challenges that existed at that time.2

 One impetus 

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

pension plan in the 1960s, in which many plan participants lost their 

pensions.3

 Along with other changes, ERISA established PBGC to pay the 

 1

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

GAO-05-325SP. (Washington, DC: February, 2005) 

2

ERISA has been amended a few times, notably in 1987 (Public Law 100-203) and again in 

1994 (Public Law 103-465), to respond to challenges facing the defined benefit pension 

system and PBGC. 

3

The company and the union agreed to terminate the plan along the lines set out in the 

collective bargaining agreement; retirees and retirement eligible employees over the age of 

60 received full pensions, and vested employees under age 60 received a lump-sum 

payment worth about 15 percent of the value of their pensions. Employees, whose benefit 

accruals had not vested, including all employees under age 40, received nothing. James A. 

Wooten, “The Most Glorious Story of Failure in Business: The Studebaker-Packard 

Corporation and the Origins of ERISA.” Buffalo Law Review, vol. 49 (Buffalo, NY: 

2001):731. 
Page 2 GAO-05-360T 

pension benefits of defined benefit plan participants, subject to certain 

limits, in the event that an employer could not.4

 ERISA also required PBGC 

to encourage the continuation and maintenance of voluntary private 

pension plans and to maintain premiums set by the corporation at the 

lowest level consistent with carrying out its obligations.5

 PBGC was thus 

mandated to serve a social purpose and remain financially self-sufficient.6

When ERISA was enacted, defined benefit pension plans were the most 

common form of employer-sponsored private pension and were growing 

both in number of plans and number of participants. In 1974, Congress 

may well have expected continued growth of defined benefit plans in the 

years and decades to come. Today, defined benefit pensions cover an ever 

decreasing percentage of the U.S. labor force, a fact that raises several 

questions about federal policy on pensions in general, and defined benefit 

plans and the PBGC, in particular. 

In light of past trends and future challenges, some of the fundamental 

questions that need to be addressed as we move forward include these: 

• Should the federal government continue to promote defined benefit 

pension plans? 

• What features of various pension plans should the government promote 

to meet retirement income security needs of increasingly mobile 

American workers? 

• What changes should be made to enhance the retirement income 

security of workers while protecting the fiscal integrity of the PBGC 

insurance program? 

• Should PBGC act as self-sustaining insurer, according to market-based 

principles, should it be a social insurance program, or should it be a 

hybrid entity? As defined benefit pension coverage declines, there is an 

 4

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

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

fewer employees. 

5

See section 4002(a) of P.L. 93-406, Sept. 2, 1974. 

6

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

temporary cash shortfalls. 
Page 3 GAO-05-360T 

inherent tension between these two approaches that Congress 

presumably did not foresee when ERISA was enacted. 

• What legislative changes are necessary to allow the pension insurance 

program and the PBGC to succeed in their missions? And how much 

authority and flexibility should be provided to PBGC to manage its risk 

and respond to the fiscal challenges it faces? 

• Should the government’s pension insurance program be used as a tool 

to provide restructuring assistance to industries that have been 

negatively affected by certain macroeconomic forces such as 

globalization and deregulation? Should such costs be handled 

differently than other pension insurance losses? 

• What portion of the PBGC’s premium revenue should be fixed versus 

variable rate premiums and for what purposes? Should variable rate 

premiums be more risk-related? If so, how can they be adjusted to 

accomplish this objective? 

• What should PBGC’s investment strategy be and what impact, if any, 

should that have on pension funding, recovery, premium, and other 

calculations? 

It is critical that we address these fundamental issues as soon as possible 

so that we take actions consistent with our broader policy objectives. 

Furthermore, failure to enact the proper reforms could expedite the 

demise of the defined benefit pension system. As part of GAO’s efforts to 

help Congress and other policymakers address such issues, I recently 

convened a group of pension experts at a Comptroller General’s Forum 

entitled “The Future of the Defined Benefit System and the PBGC.” We will 

convey the observations of the forum participants in a forthcoming GAO 

report. 

I will now turn to the specific issues before this subcommittee today. In 

particular, I will discuss some of the structural problems that limit PBGC’s 

ability to protect itself from risk and steps PBGC has taken to forecast and 

manage the risks that it faces. In summary, existing laws governing 

pension funding and premiums have not protected PBGC from 

accumulating a significant long-term deficit and have not limited PBGC’s 

exposure to “moral hazard” from the companies whose pension plans it 
Page 4 GAO-05-360T 

insures.7 The pension funding rules, under ERISA and the Internal Revenue 

Code (IRC), were not designed to ensure that plans have the means to 

meet their benefit obligations in the event that plan sponsors run into 

financial distress. Meanwhile, in the aggregate, premiums paid by plan 

sponsors under the pension insurance system have not adequately 

reflected the financial risk to which PBGC is exposed. Accordingly, 

defined benefit plan sponsors, acting rationally and within the rules, have 

been able to turn significantly underfunded plans over to PBGC, thus 

creating PBGC’s current deficit. 

Despite the challenges it faces, PBGC has proactively attempted to 

forecast and mitigate its risks. The Pension Insurance Modeling System, 

created by PBGC to forecast claim risk, has projected a high probability of 

future deficits for the agency. However, the accuracy of the projections 

produced by the model is unclear. Through its Early Warning Program, 

PBGC negotiates with companies that have underfunded pension plans 

and that engage in business transactions that could adversely affect their 

pensions. Over the years, these negotiations have directly led to billions of 

dollars of pension plan contributions and other protections by the plan 

sponsors. Moreover, PBGC has changed its investment strategy and 

decreased its equity exposure to better shield itself from market risks. 

However, despite these efforts, the agency, unlike other federal insurance 

programs, ultimately lacks adequate authority to effectively protect itself. 

Before enactment of the Employee Retirement Income Security Act of 

1974, few rules governed the funding of defined benefit pension plans, and 

participants had no guarantees that they would receive the benefits 

promised. Among other things, ERISA established rules for funding 

defined benefit pension plans and created the PBGC to protect the 

benefits of plan participants in the event that plan sponsors could not 

meet the benefit obligations under their plans. More than 34 million 

workers and retirees in about 30,000 single-employer defined benefit plans 

rely on PBGC to protect their pension benefits. 

 7

Moral hazard surfaces when the insured parties------in this case, plan sponsors------engage in 

risky behavior knowing that the guarantor will assume a substantial portion of the risk. In 

the case of the pension insurance system, this might include the willingness of parties to 

enter into agreements that increase pension liabilities, rather than taking wage increases. 

Background 
Page 5 GAO-05-360T 

PBGC finances the liabilities of underfunded terminated plans partially 

through premiums paid by plan sponsors.8

 Currently, plan sponsors pay a 

flat-rate premium of $19 per participant per year; in addition, some plan 

sponsors pay a variable-rate premium, which was added in 1987, to 

provide an incentive for sponsors to better fund their plans. For each 

$1,000 of unfunded vested benefits, plan sponsors pay a premium of $9. In 

fiscal year 2004, PBGC received nearly $1.5 billion in premiums, including 

more than $800 million in variable rate premiums, but paid out more than 

$3 billion in benefits to plan participants or their beneficiaries.9

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

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

obligations—for much of its existence. (See fig. 1.) In fiscal year 1996, the 

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

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

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

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

2003, we designated the single-employer insurance program as “high risk,” 

given its deteriorating financial condition and the long-term vulnerabilities 

of the program.10 In fiscal year 2004, PBGC’s single-employer pension 

insurance program incurred a net loss of $12.1 billion and its accumulated 

deficit increased to $23.3 billion, up from $11.2 billion a year earlier. 

Furthermore, PBGC estimated that total underfunding in single-employer 

plans exceeded $450 billion, as of the end of fiscal year 2004. 

 8

PBGC also assumes the assets of the plans it takes over in a plan termination and any 

investment income from these assets may be used to pay out benefits to participants of 

terminated plans. 

9

For most of its history, PBGC has received most of its premium income from flat-rate 

premiums. 

10See GAO, Pension Benefit Guaranty Corporation Single-Employer Insurance Program: 

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

(Washington, DC: July 23, 2003). 
Page 6 GAO-05-360T 

Figure 1: Assets, Liabilities, and Net Financial Position of PBGC’s Single-Employer Insurance Program, 1980-2004 

Existing laws governing pension funding and premiums have not protected 

PBGC from accumulating a significant long-term deficit and have not 

limited PBGC’s exposure to moral hazard from the companies whose 

pension plans it insures. The pension funding rules, under ERISA and the 

IRC, were not designed to ensure that plans have the means to meet their 

benefit obligations in the event that plan sponsors run into financial 

distress. Meanwhile, in the aggregate, premiums paid by plan sponsors 

under the pension insurance system have not adequately reflected the 

financial risk to which PBGC is exposed. Accordingly, defined benefit plan 

sponsors, acting rationally and within the rules, have been able to turn 

significantly underfunded plans over to PBGC, thus creating PBGC’s 

current deficit. Earlier this year, the Administration released a proposal 

that aims to address many of the structural problems that PBGC faces by 

calling for changes in the funding rules and premium structure, among 

other things. Meanwhile, employers who responsibly manage their defined 

benefit pension plans are concerned about their exposure to additional 

funding and premium uncertainties. 

Structural Problems 

Limit PBGC’s Ability 

to Protect Itself from 

Risk 

Source: Pension Benefit Guaranty Corporation.

-30

-20

-10

0

10

20

30

40

50

60

70

U.S. dollars in billions

Assests

Liabilities

Net position

-30

-20

-10

0

10

20

30

40

50

60

70

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

-23,305
Page 7 GAO-05-360T 

As the PBGC takeovers of severely underfunded plans suggest, the IRC 

minimum funding rules have not been designed to ensure that plan 

sponsors contribute enough to their plans to pay all the retirement 

benefits promised to date.11 The amount of contributions required under 

IRC minimum funding rules is generally the amount needed to fund that 

year’s “normal cost” – benefits earned during that year plus that year’s 

portion of other liabilities that are amortized over a period of years. Also, 

the rules require the sponsor to make an additional contribution if the plan 

is underfunded to a specified extent as defined in the law.12 However, 

sponsors of underfunded plans may sometimes avoid or reduce minimum 

funding contributions if they have earned funding credits as a result of 

favorable experience, such as contributing more than the minimum in the 

past. For example, contributions beyond the minimum may be recognized 

as a funding credit. These credits are not measured at their market value 

and accrue interest each year, according to the plan’s long-term expected 

rate of return on assets.13 If the market value of the assets falls below the 

credited amount, and the plan is terminated, the assets in the plan will not 

suffice to pay the plan’s promised benefits. Thus, some very large and 

significantly underfunded plans have been able to remain in compliance 

with the current funding rules while making little or no contributions in 

the years prior to termination (e.g., Bethlehem Steel). 

Further, under current funding rules, plan sponsors can increase plan 

benefits for underfunded plans, even in some cases where the plans are 

less than 60 percent funded. This may create an incentive for financially 

troubled sponsors to increase pension benefits, possibly in lieu of wage 

increases, even if their plans have insufficient funding to pay current 

benefit levels.14 Thus, plan sponsors and employees that agree to benefit 

increases from underfunded plans as a sponsor is approaching bankruptcy 

 11Pension funding rules include minimum funding requirements for all plans and additional 

funding requirements for underfunded plans that set minimum contribution requirements 

for plan sponsors. 

12Under one of the amendments to ERISA in 1987, an additional funding requirement rule 

was added. Generally speaking, large single-employer plans are subject to a deficit 

reduction contribution if the value of plan assets is less than 90 percent of a standardized 

liability measure. To determine whether the additional funding rule applies to a plan, the 

IRC requires sponsors to calculate this liability using the highest interest rate allowable for 

the plan year. See 26 U.S.C. 412(l)(9)(C). 

13See 26 U.S.C. 412(b). 

14Some measures exist to limit losses incurred by PBGC from benefits added to a plan 

within the 5-year period prior to plan termination. 

Minimum Funding Rules 

Do Not Prevent Plans from 

Being Severely 

Underfunded 
Page 8 GAO-05-360T 

can essentially transfer this additional liability to PBGC, potentially 

exacerbating the agency’s financial condition. 

In addition, many defined benefit plans offer employees “shutdown 

benefits,” which provide employees additional benefits, such as significant 

early retirement benefit subsidies in the event of a plant shutdown or 

permanent layoff. In general, plant shutdowns are inherently 

unpredictable, so that it is difficult to recognize the costs of shutdown 

benefits in advance and current law does not include the cost of benefits 

arising from future unpredictable contingent events.15 Under current law, 

PBGC is responsible for at least a portion of any benefit increases, 

including shutdown benefits, even if the benefit was added to the plan 

within 5 years of plan termination. However, many of these provisions 

were included in plans years ago. As a result, shutdown benefits pose a 

problem for PBGC not only because they can dramatically and suddenly 

increase plan liabilities without adequate funding safeguards, but also 

because the related additional benefit payments drain plan assets.16

Finally, because many plans allow lump sum distributions, plan 

participants in an underfunded plan may have incentives to request such 

distributions. For example, where participants believe that the PBGC 

guarantee may not cover their full benefits, many eligible participants may 

elect to retire and take all or part of their benefits in a lump sum rather 

than as lifetime annuity payments, in order to maximize the value of their 

accrued benefits. In some cases, this may create a “run on the bank,” 

exacerbating the possibility of the plan’s insolvency as assets are 

liquidated more quickly than expected, potentially leaving fewer assets to 

pay benefits for other participants. 

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

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

shifting from financially troubled companies with underfunded plans to 

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

sponsors a variable-rate premium based on the plan’s level of 

underfunding. However, these premiums do not consider other relevant 

 15See 26 U.S.C. 412(m)(4)(D). 

16Shutdown benefit payments begin immediately after a facility closes, using assets 

accumulated to pay other plan benefits. 

PBGC’s Premium Structure 

Does Not Properly Reflect 

Risks to the Insurance 

Program 
Page 9 GAO-05-360T 

risk factors, such as the economic strength of the sponsor, plan asset 

investment strategies, the plan’s benefit structure, or the plan’s 

demographic profile. PBGC is currently operated somewhat more on a 

social insurance model since it must cover all eligible plans regardless of 

their financial condition or the risks they pose to the solvency of the 

insurance program. 

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

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

widespread underfunded terminations during the same period, potentially 

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

insuring plans concentrated in vulnerable industries affected by certain 

macroeconomic forces such as deregulation and globalization that have 

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

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

overall premiums collected by PBGC amount to about 50 percent of what 

a private insurer would charge because its premiums do not adequately 

account for these market risks.17 Others note that it would be hard to 

determine the market rate premium for insuring private pension plans 

because private insurers would probably refuse to insure poorly funded 

plans sponsored by weak companies. 

Despite a series of reforms over the years, current pension funding and 

insurance laws create incentives for financially troubled firms to use 

PBGC in ways that Congress did not intend when it formed the agency in 

1974. PBGC was established to pay the pension benefits of participants in 

the event that an employer could not. As pension policy has developed, 

however, firms with underfunded pension plans may come to view PBGC 

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

presence of PBGC insurance may create certain perverse incentives that 

represent moral hazard—struggling plan sponsors may place other 

financial priorities above “funding up” their pension plans because they 

know PBGC will pay guaranteed benefits. Firms may even have an 

incentive to seek Chapter 11 bankruptcy in order to escape their pension 

obligations. As a result, once a plan sponsor with an underfunded pension 

plan experiences financial difficulty, existing incentives may exacerbate 

the funding shortfall for PBGC while also affecting the competitive 

 17Boyce, Steven, and Richard A. Ippolitio, “The Cost of Pension Insurance,” The Journal of 

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

PBGC Is Subject to Moral 

Hazard 
Page 10 GAO-05-360T 

balance within an industry. This should not be the role for the pension 

insurance system. 

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

of firms with underfunded plans creating a vicious cycle of bankruptcies 

and terminations. Firms with onerous pension obligations and strained 

finances could see PBGC as a means of shedding these liabilities, thereby 

providing them with a competitive advantage over firms that deliver on 

their pension commitments. This would also potentially subject PBGC to a 

series of terminations of underfunded plans in the same industry, as we 

have already seen with the steel and airline industries in the past 20 years. 

In addition, current pension funding and pension accounting rules may 

also encourage plans to invest in riskier assets to benefit from higher 

expected long-term rates of return. In determining funding requirements, a 

higher expected rate of return on pension assets means that the plan needs 

to hold fewer assets in order to meet its future benefit obligations. And 

under current accounting rules, the greater the expected rate of return on 

plan assets, the greater the plan sponsor’s operating earnings and net 

income. However, with higher expected rates of return comes greater risk 

of investment loss, which is not reflected in the pension insurance 

program’s premium structure. Investments in riskier assets with higher 

expected rates of return may allow financially weak plan sponsors and 

their plan participants to benefit from the upside of large positive returns 

on pension plan assets without being truly exposed to the risk of losses. 

The benefits of plan participants are guaranteed by PBGC, and weak plan 

sponsors that enter bankruptcy can often have their plans taken over by 

PBGC. 

Earlier this year, the Administration released a proposal for strengthening 

funding of single-employer pension plans. The Administration’s proposal 

focuses on three areas: 

• reforming the funding rules to ensure pension promises are kept by 

improving incentives for funding plans adequately; 

• improving disclosure to workers, investors, and regulators about 

pension plan status; and 

• adjusting premiums to better reflect a plan’s risk and ensure the 

pension insurance system’s financial solvency. 

Administration Has 

Proposed Reforms to 

Address PBGC’s LongTerm Challenges 
Page 11 GAO-05-360T 

Among other things, the proposal would require all underfunded plans to 

pay risk-based premiums and it would empower PBGC’s board to adjust 

the risk-based premium rate periodically so that premium revenue is 

sufficient to cover expected losses and to improve PBGC’s financial 

condition.18

Employer groups have expressed concern about their exposure to 

additional funding and premium uncertainties and have claimed that the 

Administration’s proposal may strengthen PBGC’s financial condition at 

the expense of defined benefit plan sponsors. For example, one 

organization has stated that in its view, the current proposal would result 

in fewer defined benefit plans, lower benefits, and more pressures on 

troubled companies. 

PBGC has proactively attempted to forecast and mitigate the risks that it 

faces. The Pension Insurance Modeling System (PIMS), created by PBGC 

to forecast claim risk, has projected a high probability of future deficits for 

the agency. However, the accuracy of the projections produced by the 

model is unclear. Also, through its Early Warning Program, PBGC 

negotiates with companies that have underfunded pension plans and that 

engage in business transactions that could adversely affect their pensions. 

Over the years, these negotiations have directly led to billions of dollars of 

pension plan contributions and other protections by the plan sponsors. 

Moreover, PBGC has begun an initiative called the Office of Risk 

Assessment that combines aspects of both PIMS and the Early Warning 

Program and will enable the agency to better quantitatively analyze claim 

risks associated with individual plan sponsors. PBGC has also changed its 

investment strategy and decreased its equity exposure to better shield 

itself from market risks. However, despite these efforts, the agency, unlike 

other federal insurance programs, ultimately lacks the authority to 

effectively protect itself, such as by adjusting premiums according to the 

risks it faces. 

 18PBGC’s board is composed of the Secretary of Labor, the Secretary of the Treasury, and 

the Secretary of Commerce. 

PBGC Has Attempted 

to Improve Its Ability 

to Forecast and 

Manage Risk but 

Ultimately Lacks 

Adequate Authority to 

Properly Do So 
Page 12 GAO-05-360T 

Over the long term, many variables, such as interest rates and equity 

returns, affect the level of PBGC claims. Moreover, large claims from a 

small number of bankruptcies constitute a majority of the risk that PBGC 

faces. Consequently, PBGC created the Pension Insurance Modeling 

System—a stochastic simulation model that quantifies risk and exposure 

for the agency over the long run. PIMS simulates the flows of claims that 

could develop under thousands of combinations of various 

macroeconomic and company and plan-specific data. In lieu of predicting 

future bankruptcies, PIMS is designed to generate probabilities for future 

claims. 

In recent annual reports, PBGC has discussed the methodologies used to 

develop PIMS. Furthermore, as far back as 1998, PBGC has reported PIMS 

results that forecast the possibility of large deficits for the agency. For 

example, at fiscal year end 2003—the most recent year for which PBGC 

has released an annual report—the model’s simulations forecasted about 

an 80 percent probability of deficit by the year 2013. This included a 10 

percent probability of the deficit reaching $49 billion within this time 

frame. These forecasts, made at the end of fiscal year 2003, did not include 

the $14.7 billion in losses that PBGC experienced from terminated plans in 

fiscal year 2004. Therefore, PIMS appears to have understated the extent 

of PBGC’s long-term deficit, given that by the end of fiscal year 2004, the 

agency’s cumulative deficit had already grown to $23.3 billion. 

The extent to which PIMS can accurately assess future claims is unclear. 

There is simply too much uncertainty about the future, with respect both 

to the performance of the economy and of companies that sponsor defined 

benefit pension plans. It is difficult to accurately forecast which industries 

and companies will face economic pressures resulting in bankruptcies and 

PBGC claims. Furthermore, because PBGC’s risk lies primarily in a 

relatively small number of large plans, the failure or survival of any single 

large plan may lead to significant variance between PBGC’s actual claims 

and the projected claims reported by PBGC in its annual reports. 

Academic papers report varying rates of success in predicting bankruptcy 

with various models that measure companies’ cash flows or financial 

ratios, such as asset-to-liability ratios. One paper we reviewed reports that 

one model succeeded at a rate of 96 percent in predicting bankruptcies 1 

year in advance and a rate of 70 percent for predicting bankruptcies 5 

years in advance.19 However, another paper concludes that no single 

 19Altman, Edward. “Predicting Financial Distress of Companies: Revisiting the Z-Score and 

Zeta Models,” July 2000. Retrieved from http://pages.stern.nyu.edu/~ealtman/Zscores.pdf 

PBGC Uses Its Pension 

Insurance Modeling 

System to Forecast Its 

Potential Exposure to 

Future Claims, but 

Forecasting Firm 

Bankruptcies Is Difficult 
Page 13 GAO-05-360T 

bankruptcy prediction model proposed in the existing literature is entirely 

satisfactory at differentiating between bankrupt and nonbankrupt firms 

and that none of the models can reliably predict bankruptcy more than 2 

years in advance.20

PBGC’s Early Warning Program is designed to ensure that pensions are 

protected by negotiating agreements with certain companies engaging in 

business transactions or events that could adversely affect their pension 

plans. Companies of particular interest to the PBGC are those that are 

financially troubled, have underfunded pension plans, and are engaged in 

transactions such as restructurings, leveraged buyouts, spin-offs, and 

payments of extraordinary dividends, to name a few. The Early Warning 

Program proactively monitors financial information services and news 

databases to identify these potentially risky transactions in a timely 

fashion. 

If PBGC, after completing an extensive screening process, concludes that 

a transaction could result in a significant loss to the pension plan, the 

agency will seek to negotiate with the company to obtain protections for 

the plan. The Early Warning Program thus raises awareness of pension 

underfunding, may change corporate behavior, and may allow PBGC to 

prevent losses before they occur. Under the program, PBGC currently 

monitors about 3,200 pension plans covering about 29 million participants. 

Since 1992, the program has protected over 2 million pension plan 

participants through about 100 settlement agreements valued at over $18 

billion (one settlement accounted for about $10 billion). Some recent 

representative cases include the 2004 settlement with Invensys that 

provided for over $175 million of additional cash contributions to the 

pension plan and the 2005 agreement with Crown Petroleum whereby the 

plan has been assumed by a financially sound parent company and $45 

million of additional cash will be contributed to the pension plan. 

 20Mossman, Charles, et al. “An Empirical Comparison of Bankruptcy Models,” The 

Financial Review, (1998) Vol 33, pp. 35-54. 

PBGC’s Early Warning 

Program Is One Tool For 

Managing Risk 
Page 14 GAO-05-360T 

PBGC has recently undertaken an initiative to create an Office of Risk 

Assessment, which will focus on improving the agency’s ability to 

quantitatively model individual firms’ claim potential. According to PBGC, 

neither PIMS nor the Early Warning Program provides this information. 

For example, PIMS projects systemwide surpluses and deficits and is not 

designed to predict specific company results. Meanwhile, the Early 

Warning Program targets specific companies, but in a manner that is 

qualitative in nature. The Office of Risk Assessment, however, will attempt 

to combine the concepts of both tools and better attempt to quantitatively 

analyze the claim risk associated with individual companies. 

PBGC has consulted with other federal agencies, such as the Federal 

Deposit Insurance Corporation (FDIC), that have implemented similar 

approaches for assessing risk. In March 2003, FDIC established a Risk 

Analysis Center. Guided by FDIC’s National Risk Committee, which is 

composed of senior managers, the center is intended to “monitor and 

analyze economic, financial, regulatory and supervisory trends, and their 

potential implications for the continued financial health of the banking 

industry and the deposit insurance funds.” The center does so by bringing 

together FDIC bank examiners, economists, financial analysts, resolutions 

and receiverships specialists, and other staff members. These members 

represent several FDIC organizational units and use information from a 

variety of sources, including bank examinations and internal and external 

research. According to FDIC, the center serves as a clearinghouse for 

information, including monitoring and analyzing economic and financial 

developments and informing FDIC management and staff of these 

developments. FDIC officials believe that the center enables them to be 

proactive in identifying industry trends and developing comprehensive 

solutions to address significant risks to the banking industry. 

In early 2004, PBGC adopted a new investment strategy to better manage 

its approximately $40 billion in assets. Although many factors that affect 

PBGC’s financial health are beyond the agency’s control, a well-crafted 

investment strategy is one of the few tools PBGC has to proactively 

manage the financial risks facing the pension insurance program. Under 

the new investment policy, PBGC is decreasing its asset allocation in 

equities from 37 percent as of fiscal year end 2003 to within a range of 15 

to 25 percent. Since many of the pension plans that PBGC insures are 

already heavily invested in equities, some pension and investment experts 

have said that the agency can create more financial stability by 

establishing an asset allocation that can hedge against losses in the equity 

markets. The equity exposure reduction ensures that PBGC’s own 

PBGC Has Developed an 

Initiative to Better 

Quantitatively Assess the 

Risk Associated with 

Individual Firms 

PBGC Has Also Taken 

Steps to Better Protect Its 

Investment Portfolio from 

Certain Market Risks 
Page 15 GAO-05-360T 

financial condition will not deteriorate to the same degree as the assets in 

the pension plans it insures. However, PBGC continues to benefit when 

equity markets rise because the plans it insures will rise in value. In 

addition, PBGC claims that this strategy moves the agency closer to the 

asset mix typically associated with private sector annuity providers. 

However, it is too soon tell what effects this new investment strategy will 

have on PBGC’s long-term financial condition. 

Although PIMS and the Early Warning Program help PBGC assess and 

manage risk to some extent, PBGC lacks the regulatory authority available 

to other federal insurance programs, such as the FDIC, to effectively 

protect itself from risk. Whereas PBGC’s premiums are determined by 

statute, Congress provided FDIC the flexibility to set premiums and adjust 

them every 6 months based on its analysis of risk to the deposit insurance 

system. Furthermore, FDIC can reject applications to insure deposits at 

depository institutions when it determines that a depository institution 

carries too much risk to the Bank Insurance Fund.21 By contrast, PBGC 

must insure all plans eligible for PBGC’s insurance coverage. Last, FDIC 

may issue formal and informal enforcement actions for deposit institutions 

with significant weaknesses or those operating in a deteriorated financial 

condition. When necessary, the FDIC may oversee the re-capitalization, 

merger, closure, or other resolution of the institution. By contrast, PBGC 

is limited to taking over a plan in poor financial condition to prevent it 

from accruing additional liabilities. PBGC has no authority to seize assets 

of the plan sponsor, who is responsible for adequately funding the plan. 

The current financial challenges facing the PBGC reflect, in part, the 

significant changes that have taken place in employer-sponsored pensions 

since the passage of ERISA in 1974. Given the decline in defined benefit 

plans over the last two decades, it is time to make changes in the rules 

governing the defined benefit system and reexamine PBGC’s role as an 

insurer. In recent years an irreconcilable tension has arisen between 

PBGC’s role as a social insurance program and its mandate to remain 

financially self-sufficient. Unless something reverses the decline in defined 

benefit pension coverage, PBGC may have a shrinking plan and participant 

 21Before granting access to the federal deposit insurance system, FDIC evaluates the 

potential risk to the funds. It assesses the adequacy of an applicant’s capital, financial 

history and condition, and its future earnings potential, as well as the general character of 

its management. 

Unlike Other Federal 

Insurance Programs, 

PBGC Has Limited Ability 

to Protect Itself From Risk 

Conclusion 
Page 16 GAO-05-360T 

base to support the program in the future and may face the likelihood of a 

participant base concentrated in certain potentially more vulnerable 

industries. In this regard, effectively addressing the uncertainties 

associated with cash balance and other hybrid pension plans may serve to 

help slow the decline in defined benefit plans. 

One of the underlying assumptions of the current insurance program has 

been that there would be a financially stable and growing defined benefit 

system. However, the current financial condition of PBGC and the plans 

that it insures threaten the retirement security of millions of Americans 

because termination of severely underfunded plans can significantly 

reduce the benefits participants receive. It also poses risks to the general 

taxpaying public, who ultimately could be made responsible for paying 

benefits that PBGC is unable to afford. 

To help PBGC manage the risks to which it is exposed, Congress may wish 

to grant PBGC additional authorities to set premiums or limit the 

guarantees on the benefits it pays to those plans it assumes. However, 

these changes would not be sufficient in themselves because the primary 

threat to PBGC and the defined benefit pension system lies in the failure of 

the funding rules to ensure that retirement benefit obligations are 

adequately funded. In any event, any legislative changes to address the 

challenges facing PBGC should provide plan sponsors with incentives to 

increase plan funding, improve the transparency of the plan’s financial 

information, and provide a means to hold sponsors accountable for 

funding their plans adequately. However, policymakers must also be 

careful to balance the need for changes in the current funding rules and 

premium structure with the possibility that any changes could expedite 

the exit of healthy plan sponsors from the defined benefit system while 

contributing to the collapse of firms with significantly underfunded plans. 

The long-term financial health of PBGC and its ability to protect workers’ 

pensions is inextricably bound to the underlying change in the nature of 

the risk that it insures, and implicitly to the prospective health of the 

defined benefit system. Options that serve to revitalize the defined benefit 

system could stabilize PBGC’s financial situation, although such options 

may be effective only over the long term. Our greater challenge is to 

fundamentally consider the manner in which the federal government 

protects the defined benefit pensions of workers in this increasingly risky 

environment. We look forward to working with Congress on this crucial 

subject. 
Page 17 GAO-05-360T 

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

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

For further information, please contact Barbara Bovbjerg at (202) 512-7215 

or George Scott at (202) 512-5932. Other individuals making key 

contributions to this testimony included David Eisenstadt, Benjamin 

Federlein, and Joseph Applebaum. 

Contacts and 

Acknowledgments 

(130477) 
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