- 18 -

greater than required minimum contributions (per sec. 4l2ib))
would be allowed as offsets, but only to the extent of the
charges for experience losses and the losses from changes in
actuarial assumptions.

The solvency maintenance requirement (new sec. 412(0))
has 2 main components: (1) disbursements from the plan (i.e.,
benefit payments, including annuity purchases, administrative
expenses and other disbursements), and (2) the plan's initial
unfunded liability multiplied by the interest rate used for
purposes of the funding standard account under section
412(b). Normal cost and other charges are added to this
amount, and credits are allowed, in the -2me manner as under
the underfunding reduction requirement.

To protect firms against possibly large increases in
their required contributions on account of this rule, the
solvency maintenance requirement would be phased in over a
5-year transition period. In addition, with respect to both
requirements, any positive credit balances that antedate 1992
would be allowed as full offsets under both the new
requirements.

Discipline in actuarial assumptions would be maintained
by use of the funding standard account concepts of experience
losses and losses from changes in actuarial assumptions.
Limiting credit for experience gains, gains from changes in
actuarial assumptions, and for greater-than-required minimum
contributions in past years buttresses that discipline and
assures that underfunded pension plans always make a
contribution in each year that they are underfunded.

PBGC guarantee

The proposal would provide that the PBGC guarantee does
not apply to benefits under a new plan or an increase in
benefits resulting from a plan amendment unless the plan is
fully funded. In addition, the proposal would provide that
the PBGC guarantee does not apply to any new unpredictable
contingent event benefits or any increases in such benefits.
An unpredictable contingent event benefit is any benefit
contingent on an event other than age, service, compensation,
death, or disability or an event which is reasonably and
reliably predicable.

Analysis of Issues
Increased funding rate

Those in favor of increasing the minimum funding
standards argue that the rate of funding required under the
Present-law minimum funding standard exposes plan
Participants and the PBGC to excessive risk. Under present
law, the funded status of a plan could deteriorate even if



-~12-

The deficit reduction contribution is the sum of {1) the
unfunded old liability amount, and (2) the unfunded new
liability amount. Calculation of these amounts is based on
the plan's current liability.

Current liability

The term "current liability" generally means all
liabilities to employees and their beneficiaries under the
plan determined as if the plan terminated. However, the value
of any “unpredictable contingent event benefit" is not taken
into account in determining current liability until the event
on which the benefit is contingent occurs.

The interest rate used in determining the current
liability of a plan, as well as the contribution required
under the special rule, is required to be within a specified
range. The permissible range is defined as a rate of interest
that is not more than 10 percent above or below the average
mid-term applicable Federal rate (AFR) for the 4-year period
ending on the last day before the beginning of the plan year
for which the interest rate is being used (or, if shorter,
the period that the AFR has been computed). The Secretary
May, where appropriate, allow a lower rate of interest except
that such rate may not be less than 80 percent of the average
rate discussed above.

Within the permissible range, the interest rate is
required to be reasonable. The determination of whether an
interest rate is reasonable depends on the cost of purchasing
an annuity sufficient to satisfy current liability. The
interest rate is to be a reasonable estimate of the interest
rate used to determine the cost of such annuity, assuming
that the cost only reflected the present value of the
payments under the annuity (i.e., and did not reflect the
seller's profit, administrative expenses, etc.).

Unfunded current liability means, with respect to any
plan year, the excess of (1) the current liability under the
plan over (2) the value of the plan's assets reduced by any
credit balance in the funding standard account. The funded
current liability percentage of a plan for a plan year s the
percentage that (1) the value of the plan's assets reduced by
any credit balance in the funding standard account is of (2)
the current liability under the plan.

Unfunded old liability amount

The unfunded old liability amount is, in general, the
amount necessary to amortize the unfunded old liability under
the plan in equal annual installments (until fully amortized)
over a fixed period of 18 plan years (beginning with the
first plan year beginning after December 31, 1988). The
“unfunded old liability" with respect to a plan is the



II. THE FEDERAL PENSION INSURANCE PROGRAM
A. Present Law and Background

Defined benefit pension plans

A defined benefit pension plan is a type of
employer-sponsored retirement plan which provides benefits to
employees covered by the plan based upon a formula specified
in the plan. For example, a defined benefic plan could
provide a benefit equal to a percentage of an employee's
average compensation multiplied by the number of years of
service with the employer. A defined benefit pian could
also, for example, provide a flat dollar benefit based on
years of service, or a specified percentage of final
compensation or average. The key feature of such a plan is
that the benefit promised is based on the plan formula, not
on the investment experience of the plan.

In order to help ensure that the promised benefits are
paid to plan participants, defined benefit plans are subject
to minimum funding requirements under both the Internal
Revenue Code and title I of the Employee Retirement Income
Security Act of 1974 ("ERISA") which require the employer
sponsoring the plan to make certain contributions to fund the
plan. These requirements are discussed in detail below.

The PBGC

- As enacted in ERISA as well as under present law, the
minimum funding requirements permit an employer to fund
benefits over a period of time. Thus, it is possible that
the plan may be terminated at a time when plan assets are not
sufficient to provide all benefits accrued by employees under
the plan. In order to protect plan participants from losing
retirement benefits in such circumstances, the Pension
Benefit Guaranty Corporation (PBGC), a corporation within the
Department of Labor, was created in 1974 by ERISA to provide
an insurance program for benefits under most defined benefit
pension plans maintainec by private employers. According to
the PBGC's latest annual report, the single-employer
insurance program currently covers more than 32 million
participants in more than 83,000 defined benefit pension
plans.

Termination of underfunded pension plans

Prior to 1986, an employer generally could, subject to
contractual obligations, terminate a single-employer plan at
any time without regard to the financial health of the
employer and without regard to the level of assets in the
plan. If a single-employer plan was terminated with assets


- 19 -

the minimum funding requirements are fully satisfied. Thus,
it is argued that, given the existence of a plan

termination insurance program, the present-law rules
providing long-term financing of increases in unfunded
liabilities create an incentive for employers to provide
benefit increases that might otherwise not be affordable. In
addition, the existence of benefit guarantees makes it less
likely that employees will express concern about the security
of their promised benefits.

As a result, supporters of increases in the minimum
funding rules believe that more rapid funding would more
appropriately limit the ability of employers to delay or
avoid funding obligations. They argue that an employer
should not have the opportunity to make pension promises that
exceed its financial capacity. They suggest that the purpose
of sound funding is to protect employee benefits by
insulating them from business risk of the employer, as well
as to protect the PBGC from systematic loss. Further, they
argue that if the risk of loss to the PBGC is not minimized,
taxpayers may ultimately have to pay for unfunded benefit
promises, just as they have had to pay for losses in the
recent savings and loan industry crisis.

Concerns have been expressed that the rate of funding
proposed by the Administration is unnecessarily high, and
that an employer who otherwise would have been able to fully
fund plan liabilities may, instead, choose bankruptcy as a
means of avoiding the faster funding of its unfunded
liability. Sharply higher contribution requirements,
particularly requirements imposed with respect to existing
unfunded liabilities, could prove burdensome for employers in
cyclical businesses. For employers who incur losses, the
increased contributions may not be fully deductible when
paid.

Others argue that the rapid rates mandated by the
Administration proposal would unduly restrict funding
flexibility under defined benefit pension plans and may cause
termination of plans by employers that are unwilling to bear
the increased current costs of funding. They argue that the
objective of greater benefit security can be obtained with a
less extensive increase in the rate of funding that is less
likely to cause the termination of defined benefit pension
plans.

Some who oppose faster funding believe that the
requirements will interfere with collective bargaining. They
suggest that the extent to which amounts earned by employees
should be divided between pension plan contributions and
other forms of compensation is more appropriately left to
employee representatives and to employers. On the other
hand, it can be argued that restraints on the collective
bargaining process are appropriate in light of the PBGC's


-21-
among all premium payers.

Opponents of increasing the PBGC premium argue that,
while risk spreading is appropriate, there is an underlying
moral hazard in the PBGC system that needs to be addressed --
the incentive to underfund knowing the PBGC will pay
benefits. Further, they argue that because te defined
benefit system in voluntary, if premiums on low-risk plans
are too high they will simply exit the system, leaving only
plans that represent significant exposure to the PBGC. The
best way to deal with systematic underfunding, they argue, is
to require employers to fund their own benefit promises.

PBGC guarantee

The Administration proposal to eliminate the PBGC
guarantee in certain circumstances is designed to limit the
PBGC's exposure to chronically underfunded plans and to
provide an incentive to employers to fund benefit increases.
The general theory behind the proposal is that employers will
not provide and employees will not want benefit increases
that are not guaranteed.

Opponents of the Administration proposal argue that the
Proposal is simply a way to limit PBGC exposure, and
undermines the whole purpose of the PBGC -- which is to
guarantee benefits. They argue that the proposal will do
nothing to help benefit security, but will make it worse by
weakening the guarantee. Further, they argue that
participants may be mislead, because they may not know that
the particular benefit or benefit increase is not guaranteed.

Some opponents of the Administration proposal agree that
the goal of limiting unfunded benefit increases in
chronically underfunded plans is appropriate, but would
address it in a different way. For example, benefit
increases in underfunded plans could be prohibited unless the
plan is funded to a certain leve., or security is provided.
Such a proposal could build on the present-law requirement
that sponsors of plans which are less than 60 percent funded
provide security in the case of plan amendments.


- 16 -

participants, the maximum amount deductible is not less than
the plan's unfunded current liability as determined under the
minimum funding rules.



-6-

first effective. Under some funding methods, there is no
past service liability component.

Acceptable methods.--Normal cost and past service
liabilit: are key elements in computations under the minimum
funding standard. Although these costs may differ
substantially, depending upon the actuarial cost method used
to value a plan's assets and liabilities, they must be
determined under an actuarial cost method permitted by ERISA.
ERISA enumerates six acceptable actuarial cost methods and
provides that additional methods may be permitted under
Treasury regulations. Normal costs and past service
liabilities under a plan are computed on the basis of an
actuarial valuation of the assets and liabilities of a plan.
Generally, an actuarial valuation is required at least once
every 3 plan years. More frequent valuations may be required
by the IRS.

Charges and credits to the funding standard account

in general.--Under the minimum funding standard, the
portion of the cost of a plan that is required to be paid for
a particular year depends upon the nature of the cost. For
example, the normal cost for a year is generally required to
be funded currently. On the other hand, costs with respect to
past service (for example, the cost of retroactive benefit
increases), experience losses, and changes in actuarial
assumptions, are spread over a period of years.

Normal cost.--Each plan year, a plan's funding standard
account is charged with the normal cost assigned to that year
under the particular acceptable actuarial cost method adopted
by the plan. The charge for normal cost will require an
offsetting credit in the funding standard account. Usually,
an employer contribution is required to create the credit.

For example, if the normal cost for a plan year is
$150,000, the funding standard account would be charged with
that amount for the year. Assuming that there are no other
credits in the account to offset the charge for normal cost,
an employer contribution of $150,000 will be required for the
year to avoid an accumulated funding deficiency.

Past service liability.--There are 3 separate charges to
the funding standard account that may arise as the result of
past service liabilities. The first applies to a plan under
which past service liability has increased due to a plan
amendment made after January 1, 1974; the second applies only
to a plan that came into existence after January 1, 1974; and
the third applies only to a plan in existence on January 1,
1974. Past service liabilities result in annual charges to
the funding standard account for a specified period of years.
Assuming that there are no other credits in the account to
offset a charge for past service liability, and employer



participant. The flat-rate per participant premium has been
increased several times since the enactment of ERISA, and is
currently $19 per participant.

The variable rate premium was enacted by the Pension
Protection Act of 1987. It was believed that underfunded
plans should bear a greater burden than well-funded plans
because they pose a greater risk of exposure to the PBGC.
The amount of the variable rate premium is $9.00 per each
$1,000 of unfunded vested benefits, up to a maximum of $53
per participant. Thus, the maximum total per participant
premium for an underfunded plan is $72.

B. Financial Status of the PBGC

As of September 30, 1991, the PBGC reported a deficit of
$2.5 billion. This is an increase over the $1.9 billion
deficit reported as of the end of the prior year. The PBGC
experienced its largest losses in the history of the
termination insurance program in the year ending September
30, 1991. The PBGC attributes these losses primarily to
lower expected recoveries from employers in bankruptcy for
plans added to PBGC's liabilities in 1990. The PBGC reports
that the defined benefit plan system is healthy as a whole,
but that some pension plans, primarily in the steel,
automobile, tire, and airline industries, are underfunded by
about $40 billion. Of this, the PBGC reports that about $13
billion is in plans sponsored by financially troubled
companies.

The PBGC has estimated its future financial status under
a. variety of assumptions. Bases on various assumptions as to
the future level of PBGC's losses, it has estimated that the
deficit could range from about $2.7 billion by the end of
2001 if losses are relatively low, to about $17.9 billion by
the end of 2001 if losses are high. According to the PBGC,
the estimate of a potential deficit of $17.9 is not a
worst-case scenario.


-4-

insufficient to pay benefits at the level guaranteed by the
PBGC, the employer was liable to the PBGC for the lesser of
the insufficiency or an amount equal to 30 percent of the
employer's net worth.

Under these rules, employers that wanted to rid
themselves of underfunded liabilities could simply terminate
the plan, and the PBGC would be liable for benefits. The
PBGC was in some cases prevented from recouping its liability
from the employer, even if the employer was financially
sound. The plan termination rules were amended to prevent
such dumping of liabilities on the PBGC by the Single
Employer Pension Plan Amendments Act (SEPPA) and were
modified further by the Pension Protection Act of 1987.

Under present law, a plan with assets insufficient to
Provide for benefit liabilities can be terminated voluntarily
by the employer only if the employer and members of the
controlled group of the employer are in financial distress.
In general, benefit liabilities are all fixed and contingent
liabilities to plan Participants and beneficiaries.

Following a distress termination, the PBGC pays out all
benefits under the plan, including guaranteed benefits and
those not guaranteed. The amount of benefits in excess of
guaranteed benefits that are paid to plan participants
depends on the level of plan funding, and the amount the PBGC
is able to recover from the employer. The employer is liable
to the PBGC for the full amount of unfunded benefit
liabilities.

Guaranteed benefits

The PBGC guarante:s vested retirement benefits (other
than those that vest s_.ely on account of the plan
termination), up to a maximum benefit of $2,352.57 per month
in 1992, The dollar limit is indexed annually for inflation.
The guarantee is reduced for benefits starting before age 65,
and does not apply to certain types of ancillary benefits.

In the case of a plan or a plan amendment that has been in
effect for less than 5 years before a plan termination, the
amount guaranteed is phased in by 20 percent a year.

Sources of PBGC funding

The PBGC is funded by assets in terminated plans,
amounts recovered from employers who terminate underfunded
plans, and by premiums paid with respect to covered plans.
All covered plans are required to pay a flat per participant
premium and underfunded plans are subject to an additional
variable premium based on the level of underfunding.

As initially enacted in ERISA, covered plans were
required to pay a flat premium to the PBGC of $1.00 per plan



-17-

IV. PROPOSALS AND ISSUES

Administration Proposals

The Administration has proposed a number of reforms
relating to the PBGC termination insurance system, including
increasing the minimum funding rules for certain plans and
modifying the PBGC guarantee with respect to plan
amendments.

Minimum funding requirements

In general, the Administration's minimum funding
Proposal would build on the changes made by the Pension
Protection Act of 1987 by requiring sponsors of underfunded
plans to pay off pension liabilities more rapidly than under
present-law rules. Alternatively, underfunded plans with
high levels of payments would be required each year to make
contributions to the plan equal to disbursements plus
interest on the plan's unfunded liability. The proposed

. rules would require underfunded plans to increase their
funding levels over a period of time.

To accomplish these goals, the proposal would replace
the current deficit reduction contribution with 2 new rules:
(1) the “underfunding reduction requirement," and (2) the
“solvency maintenance requirement". The required minimum
funding contribution would be the greatest of (a) the amount
of any funding deficiency according to the regular funding
standard account, (b) the amount required by the underfunding
reduction rule, or (c) the amount required by the solvency
maintenance rule. The two new rules would only apply to
underfunded pension plans with more than 100 participants,
and would only have a limited effect on plans with more than
100, but no more than 150 participants.

The underfunding reduction requirement (revised Code
sec. 412(1)) would apply the formula for the unfunded new
liability amount from the deficit reduction contribution to
the entire underfunding, thereby eliminating the
grandfathering of pre-1987 liabilities over an 18-year
period. As under present law, the rule would require higher
contributions from the worst funded plans. To this amount
would be added normal cost, the repayment of waived
contributions, and charges for experience losses and losses
from changes in actuarial assumptions. Credit for experience
gains, gains from changes in actuarial assumptions and

2 These and other proposals were included in the President's
fiscal year 1993 budget, and are in H.R. 4545, introduced by
Mr. Michel (by request) on March 24, 1992.


-7-

the excess is referred to as an "accumulated funding
deficiency." Unless a minimum funding waiver is obtained, an
employer whe is responsible for contributing to a plan with
an accumulated funding deficiency is subject to a 5-percent
nondeductitie excise tax on the amount of the deficiency
(sec. 4971). If the deficiency is not corrected within the
“taxable period," then an employer who is responsible for
contributing to the plan is also subject to a nondeductible
excise tax equal to 100 percent of the deficiency. The
taxable period is the period beginning with the end of the
plan year in which there is a deficiency and ending on the
earlier of (1) the date of a mailing of a notice of
deficiency with respect to the 5-percent tax or (2) the date
on which the 5-percent tax is assessed by the Internal
Revenue Service (IRS).

For example, if the balance of charges to the funding
standard account of a plan for a year would be $200,000
without any contributions, then a minimum contribution in
that amount would be required to meet the minimum funding
standard for the year to prevent an accumulated funding
deficiency. If the total contribution is not made, then the
employer (or employers) responsible for contributing to the
plan would be subject to an excise tax equal to 5 percent of
the deficiency for the year. If the deficiency were not
corrected within the specified period, then the 100-percent
excise tax would be imposed on such employer (or employers).

Actuarial cost methods

in general.--A defined benefit pension plan is required
to use an acceptable actuarial cost method to determine the
balance in its funding standard account for a year.
Generally, an actuarial cost method breaks up the cost of
benefits under the plan into annual charges consisting of a 2
elements for each plan year. These elements are referred to
as (1) normal cost, and (2) past service liability.

Normal cost.--The normal cost of a plan for a year
generally represents the cost of future benefits allocated to
the year by the funding method used by the plan for current
employees and, under some funding methods, for separated
employees. The normal cost will be funded by future
contributions to the plan (1) in level dollar amounts, (2) as
a uniform percentage of payroll, (3) as a uniform amount per
unit of service (e.g., $1 per hour), or (4) on the basis of
the actuarial present values of benefits accruing under the
Plan in particular plan years.

Past service liability.--The past service liability
element represents the cost of future benefits under the plan
that will not be funded by future plan contributions to meet
normal cost (1) on the date the plan is first effective, or
(2) on the date a plan amendment increasing plan benefits is



PROPOSALS AND ISSUES RELATING
TO THE
FINANCIAL CONDITION OF THE

PENSION BENEFIT GUARANTY CORPORATION (PBGC) -

Scheduled for a Hearing
Before the
SUBCOMMITTEE ON OVERSIGHT
of the
HOUSE COMMITTEE ON WAYS AND MEANS

On August 11, 1992

Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
August 10, 1992
JICX-33-92


-10-

and, under the new assumptions, the accrued liability of a
plan is less than the accrued liability computed under the
previous assumptions, the decrease is a gain from charges in
actuarial assumptions. If the new assumptions result in an
increase in the accrued liability, the plan has a loss from
changes in actuarial assumptions. The accrued liability of a
pian is the actuarial present value of projected pension
benefits under the plan that will not be funded by future
contributions to meet normal cost. Under the funding
standard, the gain or loss for a year from changes in
actuarial assumptions is amortized over a period of 10 plan
years (30 plan years in the case of a multiemployer plan),
resulting in credits or charges to the funding standard
account.

Experience gains and losses.--In determining plan
funding under an actuarial cost method, a plan's actuary
generally makes certain assumptions regarding the future
experience of a plan. These assumptions typically involve
rates of interest, mortality, disability, salary increases,
and other factors affecting the value of assets and
liabilities. The actuarial assumptions are required to be
reasonable in the aggregate. If, on the basis of these
assumptions, the contributions made to the plan result in
actual unfunded liabilities that are less than anticipated by
the actuary, then the excess is an experience gain. If the
actual unfunded liabilities are greater than those
anticipated, then the difference is an experience loss. For
a single-employer plan, experience gains and losses for a
year are amortized over a 5-year period (15 plan years in the
case of a multiemployer plan).

Waived funding deficiencies.--Under the funding
standard, the amount Of a waived funding deficiency is
amortized over a period of 5 plan years, beginning with the
year in which the waiver is granted. Each year, the funding
standard account is charged with the amount amortized for
that year unless the plan becomes fully funded. The interest
rate used for purposes of determining the amortization on the
waived amount is the greater of (1) the rate used in
computing costs under the plan, or (2) 150 percent of the
mid-term applicable Federal interest rate (APR) in effect for
the first month of the plan year.

With respect to applications for waivers submitted after
April 7, 1986, SEPPAA provides that the IRS is authorized to
require security to be granted as a condition of granting a
waiver of the minimum funding standard if the sum of the
plan's accumulated funding deficiency and the balance of any
outstanding waived funding deficiencies exceeds $2 million.

Switchback liability.--ERISA provides that certain plans
may elect to use an alternative minimum funding standard
account for any year in lieu of the funding standard account.



-9-

contribution will be required for the year to avoid and
accumulated funding deficiency.

In the case of a plan that was in existence on January
1, 1974, the funding standard account is charged annually
with a portion of the past service liability determined as of
the first day of the plan year of which the funding standard
applied to the plan (generally the plan year beginning in
1976). In the case of a single-employer plan, the amount of
the liability with which the account is charged for a year is
based on amortization of the past service liability over a
period of 40 plan years. The liability is required to be
amortized (in much the same manner as a 40-year mortgage) in
equal annual installments over the 40-year funding period
unless the plan becomes fully funded.

A plan that was not in existence on January 1, 1974, is
generally required to determine past service liability as of
the first day of its first plan year beginning after
September 2, 1974 (the date ERISA was enacted). This
liability is required to be amortized by a single-employer
plan in equal-annual installments over a period of 30 plan
years. Accordingly, if there are no other credits in the
account to offset the charge for this past service liability,
and if the plan does not become fully funded, annual employer
contributions will be required for 30 plan years to offset
charges for this past service liability.

With respect to all plans (whether or not in existence
on January 1, 1974), if a net benefit increase takes place as
the result of a plan amendment, then the unfunded past
service liability attributable to the net increase is
determined that year and amortized over a period of 30 years.

For example, assume that a plan uses the calendar year
as the plan year. Further, assume that, during 1987, the plan
is amended to increase benefits and that the net resuit of
plan amendments for 1987 is that the past service liability
under the plan is increased by $500,000. In addition, the
plan's actuary uses an interest rate <£ 8 percent in
determining plan costs. The 30-year scnedule requires that
$44,414 be charged to the funding standard account each year
to amortize the past service liability.

Accordingly, for each year in the 30-year period
beginning with 1987, the plan's funding standard account is
charged with the amount of $44,414. If there are no other
credits in the account to offset the charge for past service
liability, an employer contribution of $44,414 would be
required for each of the 30 years to avoid and accumulated
funding deficiency unless the plan becomes fully funded.

Gains and losses from changes in assumptions.--If the
actuarial assumptions used for funding a plan are revised



-6-
III. MINIMUM FUNDING STANDARD AND DEDUCTIONS

Present Law

In general

The minimum funding requirements are designed to provide
at least a certain level of benefit security by requiring the
employer to make certain minimum contributions to a defined
benefit plan. The requirements recognize that, in an on-going
plan, pension liabilities are generally a long-term _
liability. Thus, benefits are not required to be immediately
funded, but can be funded over a long period of time.

The minimum funding requirements provide the employer
considerable flexibility in determining the amount of the
contribution that must be or can be made in any given year.
The minimum required or maximum permitted contribution that
can be made depends on the funding or actuarial cost method
used by the plan and the actuarial assumptions used by the
plan actuary.

In response to concerns about the financial status of
underfunded pension plans, the minimum funding standards were
modified, and special additional funding requirements were
added for underfunded pension plans by the Pension Protection
Act of 1987.

The minimum funding standards and the special rules for
underfunded pension plans are discussed in detail below.

Minimum funding standard

In general

Under the Code and ERISA, certain defined benefit
pension plans are required to meet a minimum funding standard
for each plan year. As an administrative aid in the
application of the funding standard, each defined benefit
pension plan is required to maintain a special account called
a "funding standard account" to which specified charges and
credits (including credits for contributions to the plan) are
to be made for each plan year. If, as of the close of a plan
year, the account reflects credits equal to or in excess of
charges, the plan is treated as meeting the minimum funding
Standard for the year. Thus, as a general rule, the minimum
contribution for a plan year is determined as the amount by
which the charges to the account would exceed credits to the
account if no contribution were made to the plan.

Accumulated funding deficiencies

If, as of the close of any plan year, charges to the
funding standard account exceed credits to the account, then



~ 20 -

unique role as guarantor of an employer's benefit promises to
employees. ecause employees are assured of receipt of their
benefits from the PBGC if the employer is unable to meet its
benefit commitments, some argue that the normal arm's-lergth
nature of the collective bargaining process is weakened and
that employees have less incentive to bargain for adequate
funding by the employer.

Some argue that a more extensive evaluation of the
present-law funding requirements is appropriate. For
example, the flexibility provided to employers in selecting
the method of funding to be used for a particular plan could
be reexamined. The particular characteristics of employers
in various industries could be studied to determine whether
certain funding methods are more appropriate or desirable
from a benefit security perspective. The flexibility in
choosi:g actuarial assumptions could also be reexamined.

The PBGC reports that most of its exposure is from
collectively bargained plans that provide a flat benefit
(e.g., $20 per month times number of years of service).
Under such plans, the flat benefit amount is increased
periodically. The present-law funding rules do not permit
increases in the flat benefit to be anticipated. In
contrast, in plans based on compensation, increases in
compensation can be anticipated. Thus, some argue that
increases in flat benefits should be permitted to be
anticipated so that the benefits can be funded in advance.

Some argue that such a proposal should not be adopted,
or should be adopted only with appropriate restrictions to
prevent employers who want to increase deductions from
anticipating increases in benefits that may never take place.
On the other hand, proponents of the proposal argue that the
employer does not have an incentive to overestimate benefit
increases because there is limited ability to recoup any
overfunding. First, in most collectively bargained plans,
the employer has no incentive to overfund, because any excess
pension assets revert to employees on plan termination.
Second, even if the employer has a right to any reversion,
the present-law excise tax on reversions substantially
reduces the amount of excess assets an employer can claim.

Others doubt that permitting increases in flat benefits
will have any real impact on plan funding. Such plans
typically are underfunded before any increases are granted.
If the employer does not fund existing benefits, then the
employer is unlikely to take advantage of the opportunity to
fund benefit increases that have not been granted.

Some have suggested that an alternative way to protect
against pension losses would be to increase the PBGC premiums
for all plans. They argue that the PBGC program is an
insurance program, so that risk of loss should be spread



I. OVERVIEW

A defined benefit pension plan is a type of
employer~sponsored retirement plan which provides benefits to
employees covered by the plan based on a formula specified in
the plan. In order to provide benefit security to plan
Participants, the Internal Revenue Code and title I of the
Employee Retirement Income Security Act of 1974 (ERISA)
impose minimum funding requirements on the sponsor of a
defined benefit pension plan. L

The minimum funding requirements provide employers
considerable flexibility in determining the minimum required
contribution, and also permit benefits to be funded over a
long period of time. Thus, it is possible that a defined
benefit plan may be terminated at a time when plan assets are
insufficient to pay promised benefits.

ERISA created the Pension Benefit Guaranty Corporation
(PBGC) in order to protect plan participants in the event a
defined benefit pension plan terminates with insufficient
assets. The PBGC guarantees basic retirement benefits, up to
a current dollar maximum benefit of $2,352.57 per month.

In its most recent annual report, the PBGC reported a
deficit of $2.5 billion. The PBGC reports that the defined
benefit system as a whole is relatively healthy, but that
certain pension plans, primarily in certain industries, are
underfunded by about $40 billion, about $13 billion of which
is in plans sponsored by financially troubled companies. The
PBGC forecasts that, depending on the level of future losses,
its deficit could increase to between $2.7 billion and $17.9
billion by the end of fiscal year 2001.

Despite recent changes in plan funding rules designed to
increase the level of plan funding, the risk of loss upon
plan termination has increased. To deal with this loss of
pension security and increased risk to the PBGC, the
Administration has propose¢ a number of changes to present
law, including increasing minimum funding contributions for
underfunded plans, and eliminating the PBGC guarantee for
certain benefits and benefit increases.


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unfunded current liability of the plan as of the beginning of
the first plan year beginning after December 31, 1987,
determined without regard to any plan amendment adopted after
October 16, 1987, that increases plan liabilities (other than
amendments adopted pursuant to certain collective bargaining
agreements).

Unfunded new liability amount

The unfunded new liability amount for a plan year is the
applicable percentage of the plan's "unfunded new liability."
Unfunded new liability means the unfunded current liability
of the plan for the plan year, determined without regard to
{1) the unamortized portion of the unfunded old liability
(and the unamortized portion of certain unfunded liability
from certain benefit increases) and (2) the liability with
respect to any unpredictable contingent event benefits,
without regard to whether or not the event has occurred.
Thus, in calculating the unfunded new liability, all
unpredictable contingent event benefits are disregarded, even
if the event on which that benefit is contingent has
occurred.

If the funded current liability percentage is less than
35 percent, then the applicable percentage is 30 percent.
The applicable percentage decreases by .25 of one percentage
point for each 1 percentage point by which the plan's funded
current liability percentage exceeds 35 percent.

Unpredictable contingent event benefits

The value of any unpredictable contingent event benefit
is not considered in determining current liability until the
event has occurred. If the event on which an unpredictable
contingent event benefit is contingent occurs during the pian
year and the assets of the plan are less than current
liability (calculated after the event has occurred), then an
additional funding contribution (over and above the minimum
funding contribution otherwise due) is required.

Unpredictable contingent event benefits include benefits
that depend on contingencies that, like facility shutdowns or
reductions or contractions in workforce, are not reliably and
reasonably predictable. The event on which an unpredictable
contingent event benefit is contingent is generally not
considered to have occurred until all events on which the
benefit is contingent have occurred.

The amount of the additional contribution is generally
equal to the greater of (1) the unfunded portion of the
benefits paid during the plan year (regardless of the form in
which paid), including (except as provided by the Secretary)
any payment for the purchase of an annuity contract with
respect to a participant with respect to unpredictable


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Controlled group liability

The funding requirements applicable to a plan are
imposed on all employers that are members of the same
controlled group of corporations as the employer who is
responsible for making the contributions.

Sanction for failure to meet minimum funding standard

If, as of the close of any plan year, charges to the
funding standard account exceed credits to the account, then
the excess is referred to as an "accumulated funding
deficiency." Unless a minimum funding waiver is obtained, an
employer who is responsible for contributing to a plan (and
the controlled group of which the employer is a part) with an
accumulated funding deficiency is subject to a 10-percent
nondeductible excise tax (5 percent in the case of a
multiemployer plan) on the amount of the deficiency (sec.
4971). If the deficiency is not corrected within the
“taxable period," then an employer who is responsible for
contributing to the plan (and the controlled group of which
the employer is a part) is also subject to a nondeductible
excise tax equal to 100 percent of the deficiency. The
taxable period is the period beginning with the end of the
pian year in which there is a deficiency and ending on the
earlier of (1) the date of a mailing of a notice of
deficiency with respect to the 10-percent tax, or (2) the
date on which the 10-percent tax is assessed by the IRS.

Deductions for employer contributions

The contributions of an employer to a qualified plan are
deductible in the year for which the contributions are paid,
within limits (sec. 404). No deduction is allowed, however,
for a contribution that is not an ordinary and necessary
business expense or an expense for the production of income.
The deduction limits applicable to an employer's contribution
depend on the type of plan to which the contribution is made
and may depend on whether an employee covered by the plan is
also covered by another plan of the employer. However, no
deduction is allowed with respect to contributions or
benefits in excess of the overall limits on contributions or
benefits. .

Under the Internal Revenue Code, a 10-percent
nondeductible excise tax is imposed on nondeductible
contributions to a qualified plan. The purpose of the excise
tax is to discourage employers from making excessive
contributions to a plan in order to obtain the benefit of
tax-free growth on the contributions.

A special deduction rule applies to underfunded defined
benefit pension plans. In the case of a single-employer
defined benefit pension plan which has more than 100


INTRODUCTION

This document,! prepared by the staff of the Joint
Committee on Taxation, provides a discussion of proposals and
issues relating to the financial condition of the Pension
Benefit Guaranty Corporation (PBGC). The Oversight
Subcommittee of the House Committee on Ways and Means has
scheduled a public hearing on August 11, 1992, on the PBGC,
Federal contingent liabilities under the defined benefit
pension plan program, and PBGC's information system. -

Part I of the document is an overview. Part II
discusses present law and background of the Federal pension
insurance program and the financial condition of the PBGC.
Part III describes present-law minimum funding standards and
deductions. Part IV discusses the administration proposals
and related issues.

1 this document may be cited as follows: Joint Committee on
Taxation, Proposals and Issues Relating to the Financial
Condition of the Pension Benefit Guaranty Corporation (PBGC)
(JCX-33-92), August 10, 1992.



CONTENTS

INTRODUCTION. cc cece cence cece ence eee re see ree enseeeeeee i

T.

It.

OVERVIEW. . ccc eee cece cee cere c erect eee eee eesee 2
THE FEDERAL PENSION INSURANCE PROGRAM........... 3
A. Present Law and Background.......esseeeeeens 3
B. Pinancial Status of the PBGC.............05. 5
MINIMUM FUNDING STANDARD AND DEDUCTIONS......... 6

PROPOSALS AND ISSUES......cceeeeeeececvcuccssees 17



-ll-

ERISA prescribes specified annual charges and credits to the
alternative account. No accumulated funding deficiency is
considered to exist for the year if a contribution meeting
the requirements of the alternative account is made, even if
a smaller contribution is required to balance charges and
credits in the alternative account than would be required to
balance the funding standard account for a plan year.

During years for which contributions are made under the
alternative account, an employer must also maintain a record
of the charges and credits to the funding standard account.
If the plan later switches back from the alternative account
to the funding standard account, the excess, if any, of
charges over credits at the time of the change ("the
switchback liability") must be amortized over a period of 5
plan years.

Reasonableness of actuarial assumptions.--All costs,
liabilities, interest rates, and other factors are required
to be determined on the basis of actuarial assumptions and
methods (1) each of which is reasonable individually or (2)
which result, in the aggregate, in a total plan contribution
equivalent to a contribution that would be obtained if each
assumption were reasonable. In addition, the assumptions are
required to reflect the actuary's best estimate of experience
under the plan.

Special rules for underfunded plans

In _ general

A special funding rule applies to underfunded
single-employer defined benefit pension plans (other than
Plans with no more than 100 participants on any day in the
preceding plan year). This special funding rule was adopted
due to Congressional concerns regarding the solvency of the
defined benefit pension plan system and that the generally
applicable funding rules were not in all cases sufficient to
ensure that plans would be adequately funded.

Calculation of deficit reduction contribution

With respect to plans subject to the special rule, the
minimum required contribution is, in general, the greater of
(1) the amount determined under the normal funding rules, or
{2) the sum of (i) normal cost, (ii) the amount necessary to
amortize experience gains and losses over 5 years and gains
and losses resulting from changes in actuarial assumptions
over 10 years, and (iii) the deficit reduction contribution.
In addition, a special funding rule applies with respect to
benefits that are contingent on unpredictable events. In no
event is the amount of the contribution to exceed the amount
necessary to increase the funded ratio of the plan to 100
percent.


-14-

contingent event benefits, and (2) the amount that would be
determined for the year if the unpredictable contingent event
benefit liabilities were amortized in equal annual
installments over 7 years, beginning with the plan year in
which the event occurs. .

The rule relating to unpredictable contingent event
benefits is phased in for plan years beginning in 1989
through 2001.

Small plan rule -

In the case of a plan with more than 100 but no more
than 150 participants during the preceding year, the amount
of the additional deficit reduction contribution is
determined by multiplying the otherwise required additional
contribution by 2 percent for each participant in excess of
100.

Full funding limitation

No contribution is required or permitted under the
minimum funding rules to the extent the plan is at the full
funding limitation. In addition, under present law, subject
to certain limitations, an employer may make deductible
contributions to a defined benefit pension plan up to the
full funding limitation. The full funding limitation is
generally defined as the excess, if any, of (1) the lesser of
(a) the accrued liability under the plan (including normal
cost) or (b}) 150 percent of the plan's current liability,
over (2) the lesser of (a) the fair market value of the
plan's assets, or (b) the actuarial value of the plan's
assets (sec. 412(c)(7)).

Funding waivers

Within limits, the IRS is permitted to waive all or a
portion of the contributions required under the minimum
funding standard for a plan year. A waiver may be granted if
the employer (or employers) responsible for the contribution
could not make the required contribution without temporary
substantial business hardship. A waiver may. be granted only
if the business hardship is temporary an. -f the entire
controlled group of which the employer is a member, as well
as the employer itself, is experiencing the hardship. No more
than 3 waivers may be granted within any period of 15
consecutive plan years. The IRS may require an employer to
provide security as a condition of granting a waiver.

The IRS is authorized to require security to be granted
as a condition of granting a waiver of the minimum funding
standard if the sum of the plan's accumulated funding
deficiency and the balance of any outstanding waived funding
deficiencies exceeds $1 million.