United States General Accounting Office 

GAO Testimony 

Before the Committee on Education and 

the Workforce, House of Representatives 

For Release on Delivery 

Expected at 10:30 a.m. EST 

Wednesday, October 29, 2003 PRIVATE PENSIONS 

Changing Funding Rules 

and Enhancing Incentives 

Can Improve Plan Funding 

Statement of Barbara D. Bovbjerg, Director, 

Education, Workforce, and Income Security Issues 

GAO-04-176T 

Highlights of GAO-04-176T, a report to the 

Committee on Education and the 

Workforce, House of Representatives 

Over the last few years, the total 

underfunding in the defined-benefit 

pension system has deteriorated to 

the point where the Pension 

Benefit Guaranty Corporation 

(PBGC), the federal agency 

responsible for protecting private 

sector defined benefit plan 

benefits, estimates that total plan 

underfunding grew to more than 

$400 billion as of December 31, 

2002, and still exceeded $350 

billion as of September 4, 2003. 

PBGC itself faced an estimated $8.8 

billion accumulated deficit as of 

August 31, 2003. Deficiencies in 

current funding and related 

regulations have contributed to 

several large plans recently 

terminating with severely 

underfunded pension plans. 

This testimony provides GAO’s 

observations on a variety of 

regulatory and legislative reforms 

that aim to improve plan funding 

and better protect the benefits of 

millions of American workers and 

retirees while minimizing the 

burden to plan sponsors of 

maintaining defined-benefit plans. 

October 29, 2003 

PRIVATE PENSIONS 

Changing Funding Rules and Enhancing 

Incentives Can Improve Plan Funding 

Recent terminations of severely underfunded pension plans suggest that 

current funding rules do not provide adequate mechanisms for maintaining 

adequate funding of pension plans. Funding inadequacies place the 

retirement security of millions of American workers and retirees, along with 

PBGC, at risk. While external factors, such as falling stock prices, low 

interest rates, and slow economic growth, have contributed to widespread 

pension underfunding, the defined-benefit system also faces structural 

problems that extend beyond cyclical economic conditions. Stagnant growth 

of the defined-benefit system, along with several large recent terminations of 

underfunded pension plans, has left PBGC in a precarious financial 

condition as the insurer of pension benefits. 

There are two general approaches to funding reform that may improve the 

funding of defined-benefit pension plans. The first approach would change 

the funding requirements directly. These measures could address reforms to 

the use of termination liability instead of current liability, additional funding 

requirements, and lump-sum distributions. The second, more indirect 

approach would seek to improve plan funding by providing better incentives 

for sponsors to keep their plans better funded. Options in this category could 

include requirements broadening the disclosure of plan investments and 

termination liability information to plan participants and their 

representatives. These reforms, as part of a comprehensive package, could 

increase the likelihood that workers and retirees receive promised benefits, 

while not creating an undue regulatory or financial burden on sponsors. 

Recent unfavorable economic conditions have contributed to widespread 

underfunding and conspired to place well-meaning plan sponsors in 

difficult positions. Although comprehensive reform should include 

improving plan funding as the key vehicle to stabilize the long-term 

health of the defined-benefit system, Congress may seek to balance 

improvements in funding and accountability against the short-term needs 

of some sponsors who may have difficulty making plan contributions. 

www.gao.gov/cgi-bin/getrpt?GAO-04-176T. 

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Barbard D. 

Bovbjerg at (202) 512-7215 or 

bovbjergb@gao.gov.. 

Figure 2: Total Underfunding in PBGC-Insured Single-Employer Plans, 1980-2003 

Dollars in billions 

400 

350 

300 

250 

200 

150 

100 

50 

0 

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

Source: PBGC. 

Note: Figure for 2003 is an estimate, as of September 4, 2003. 
Mr. Chairman and Members of the Committee: 

I am pleased to be here today to discuss improving the funding of singleemployer defined-benefit plans.1

 As all of you are aware, this is a crucial 

issue threatening the retirement security of millions of America’s workers 

and retirees. Underfunded plans sponsored by weak or bankrupt 

employers have drained the financial resources of the Pension Benefit 

Guaranty Corporation (PBGC), the backstop federal agency that insures 

the benefits promised by these plan. PBGC’s single-employer insurance 

program currently faces an estimated deficit of $8.8 billion as of August 31, 

2003, following the largest 1-year loss in the agency’s history. This deficit 

could likely increase during the next few years, with PBGC estimating that 

by the end of fiscal year 2003, total underfunding in financially troubled 

firms could exceed $80 billion.2

 We believe that an appropriate 

comprehensive policy response can stabilize the funding of these pension 

plans, thereby protecting workers’ benefits for the foreseeable future. 

Reforming the rules that regulate how sponsors fund their pension plans is 

an essential part of this response. I hope my testimony will help clarify 

some of the key issues as the Congress and the relevant agencies choose 

how to respond to these serious financial challenges. As you requested, I 

will discuss some options to improve the funding status of defined-benefit 

plans. 

1

A defined-benefit plan promises a benefit that is generally based on an employee’s salary 

and years of service. The employer is responsible for funding the benefit, investing and 

managing plan assets, and bearing the investment risk. In contrast, under a defined 

contribution plan, benefits are based on the contributions to and investment returns on 

individual accounts, and the employee bears the investment risk. There are two federal 

insurance programs for defined-benefit plans: one for single-employer plans and another 

for multiemployer plans. Our work was limited to the PBGC program to insure the benefits 

promised by single-employer defined-benefit pension plans. Single-employer plans provide 

benefits to employees of one firm or, if plan terms are not collectively bargained, 

employees of several unrelated firms. 

2

According to PBGC, for example, companies whose credit quality is below investment 

grade sponsor a number of plans. PBGC classified such plans as reasonably possible 

terminations if the sponsors’ financial condition and other factors did not indicate that 

termination of their plans was likely as of year-end. See PBGC 2002 Annual Report, p. 41. 

The independent accountants that audited PBGC’s financial statement reported that PBGC 

needs to improve its controls over the identification and measurement of estimated 

liabilities for probable and reasonably possible plan terminations. According to an official, 

PBGC has implemented new procedures focused on improving these controls. See Audit of 

the Pension Benefit Guaranty Corporation’s Fiscal Year 2002 and 2001 Financial 

Statements in PBGC Office of Inspector General Audit Report, 2003-3/23168-2 

(Washington, D.C.: Jan. 30, 2003). 

Page 1 GAO-04-176T 
To identify the types of reform that may improve funding for definedbenefit (DB) pension plans, we reviewed proposals for reforming the 

single-employer program made by the Department of the Treasury, PBGC, 

and pension professionals. We also discussed with PBGC officials, and 

examined annual reports and other available information related to the 

funding and termination of three pension plans: the Anchor Glass 

Container Corporation Service Retirement Plan, the Pension Plan of 

Bethlehem Steel Corporation and Subsidiary Companies, and the Polaroid 

Pension Plan. We selected these plans because they represented the 

largest losses to PBGC in their respective industries in fiscal year 2002. 

PBGC estimates that, collectively, the plans represented over $4 billion in 

losses to the program at plan termination. At the request of this 

committee, we will release a report at the end of this month on the 

financial condition of the PBGC single-employer pension program and 

related issues of pension plan reform. 

To summarize my responses, there are two general approaches to funding 

reform that may improve the funding of defined-benefit pension plans. The 

first approach would change the funding requirements directly. These 

measures could encompass reforms to the use of current and termination 

liability in plan funding calculations,3

 additional funding requirements, 

credit balances, unfunded benefits or benefit increases, and lump-sum 

distributions. The second, more indirect approach would seek to improve 

plan funding by providing better incentives for sponsors to keep their 

plans better funded. Options in this category could include requirements 

broadening the disclosure of plan investments and termination liability 

information to plan participants and their representatives, the 

restructuring of PBGC’s variable-rate premium to incorporate risk factors 

other than the level of underfunding, and making modifications to certain 

guaranteed benefits that could decrease losses incurred from underfunded 

plans. Reforms adopted to directly change the funding requirements or 

improve plan funding through providing incentives for sponsors are not 

mutually exclusive, and several variations exist within each reform option. 

These reforms, taken separately or in coordination, could increase the 

likelihood of plans receiving adequate funding to ensure that workers and 

retirees receive promised benefits. 

3

A plan’s termination liability measures the value of accrued benefits using assumptions 

appropriate for a terminating plan, while its current liability measures the value of accrued 

benefits using assumptions specified in applicable laws and regulations. 

Page 2 GAO-04-176T 
Background Before enactment of the Employee Retirement and Income Security Act 

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

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

the benefits promised. When Studebaker’s pension plan failed in the 1960s, 

for example, many plan participants lost their pensions.4

 Such experiences 

prompted the passage of ERISA to better protect the retirement savings of 

Americans covered by private pension plans. Along with other changes, 

ERISA established PBGC to pay the pension benefits of participants, 

subject to certain limits, in the event that an employer could not.5

 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.6 

Under ERISA, the termination of a single-employer defined-benefit plan 

results in an insurance claim with the single-employer program if the plan 

has insufficient assets to pay all benefits accrued under the plan up to the 

date of plan termination.7

 PBGC finances the unfunded liabilities of 

terminated plans partially through premiums paid by plan sponsors. 

Currently, plan sponsors pay a flat-rate premium of $19 per participant per 

year; in addition, some pay a variable-rate premium, which was added in 

4

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 age 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. 

5

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

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

fewer employees. 

6

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

7

The termination of a fully funded defined-benefit pension plan is termed a standard 

termination. Plan sponsors may terminate fully funded plans by purchasing a group annuity 

contract from an insurance company under which the insurance company agrees to pay all 

accrued benefits or by paying lump-sum benefits to participants if permissible. Terminating 

an underfunded plan is termed a distress termination if the plan sponsor requests the 

termination or an involuntary termination if PBGC initiates the termination. PBGC may 

institute proceedings to terminate a plan if, among other things, the plan will be unable to 

pay benefits when due or the possible long-run loss to PBGC with respect to the plan may 

reasonably be expected to increase unreasonably if the plan is not terminated. See 29 

U.S.C. 1342(a). PBGC may pay only a portion of the claim because ERISA places limits on 

PBGC’s benefit guarantee. 

Page 3 GAO-04-176T 
1987 to provide an incentive for sponsors to better fund their plans. The 

variable-rate premium, which started at $6 for each $1,000 of unfunded 

vested benefits, was initially capped at $34 per participant. The variable 

rate was increased to $9 for each $1,000 of unfunded vested benefits 

starting in 1991, and the cap on variable-rate premiums was removed 

starting in 1996. 

Following the enactment of ERISA, however, concerns were raised about 

the potential losses that PBGC might face from the termination of 

underfunded plans. To protect PBGC, ERISA was amended in 1986 to 

require that plan sponsors meet certain additional conditions before 

terminating an underfunded plan. For example, sponsors could voluntarily 

terminate their underfunded plans only if they were bankrupt or generally 

unable to pay their debts without the termination. 

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

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

liabilities—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. PBGC 

estimates that this deficit grew to $8.8 billion by August 31, 2003, its largest 

deficit in the program’s history both in real and nominal terms. From less 

than $50 billion as of December 31, 2000, the total underfunding in singleemployer plans grew to more than $400 billion as of December 31, 2002, 

and still exceeds $350 billion according to recent estimates by PBGC. (See 

fig 2.) Despite the program’s large deficit, according to a PBGC analysis, 

the single-employer program was estimated to have enough assets to pay 

benefits through 2019, given the program’s conditions and PBGC 

assumptions as of the end of fiscal year 2002.8

 However, losses since that 

time may have shortened the period over which the program will be able 

to cover promised benefits. In July of this year, because of serious risks to 

8

The estimate assumes: (1) a rate of return on all PBGC assets of 5.8 percent and a discount 

rate on future benefits of 5.67 percent; (2) no premium income and no future claims beyond 

all plans with terminations that were deemed “probable” as of September 30, 2002; (3) 

administrative expenses of $225 million in fiscal year 2003, $229 million per year for fiscal 

years 2004-2014, and $0 thereafter; (4) mid-year termination for “probables”; and (5) that 

PBGC does not assume control of “probable” assets and future benefits until the date of 

plan termination. 

Page 4 GAO-04-176T 
the single-employer program’s viability, we placed the PBGC on our highrisk list.9 

Figure 1: Assets, Liabilities, and Net Position of the Single-Employer Pension Insurance Program, Fiscal Years 1976-2002 

2002 Dollars in billions 

1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 

Assets 

Liabilities 

Net position 

Source: PBGC annual reports. 

Note: Amounts for 1986 do not include plans subsequently returned to a reorganized LTV 

Corporation. We adjusted PBGC data using the Consumer Price Index for All Urban Consumers: All 

Items. 

9

See U.S. General Accounting Office, Pension Benefit Guaranty Corporation SingleEmployer Insurance Program: Long-Term Vulnerabilities Warrant “High Risk” 

Designation, GAO-03-1050SP (Washington, D.C.: July 23, 2003). 

Page 5 GAO-04-176T 

30 

25 

20 

15 

10 

5 

0 

-5 

-10 
Figure 2: Total Underfunding in PBGC-Insured Single-Employer Plans, 1980 - 2003 

Dollars in billions 

400 

350 

300 

250 

200 

150 

100 

50 

0 

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

Source: PBGC. 

Note: 2003 figure is an estimate, as of September 4, 2003. 

For the most part, liabilities of the single-employer pension insurance 

program are comprised of the present value of insured participant 

benefits. PBGC calculates present values using interest rate factors that, 

along with a specified mortality table, reflect annuity prices, net of 

administrative expenses, obtained from surveys of insurance companies 

conducted by the American Council of Life Insurers.10 In addition to the 

estimated total liabilities of underfunded plans that have actually 

terminated, PBGC includes in program liabilities the estimated unfunded 

liabilities of underfunded plans that it believes will probably terminate in 

the near future.11 PBGC may classify an underfunded plan as a probable 

termination when, among other things, the plan’s sponsor is in liquidation 

under federal or state bankruptcy laws. 

10In 2002, PBGC used an interest rate factor of 5.70 percent for benefit payments through 

2027 and a factor of 4.75 percent for benefit payments in the remaining years. 

11Under Statement of Financial Accounting Standard Number 5, loss contingencies are 

classified as probable if the future event or events are likely to occur. 

Page 6 GAO-04-176T 
Several Factors Have 

Contributed to PBGC’s 

Current Financial 

Difficulties 

As we reported to this committee in September of this year,12 several 

factors have contributed to PBGC’s and plans’ current financial 

difficulties. The financial condition of the single-employer pension 

insurance program returned to an accumulated deficit in 2002 largely due 

to the termination, or expected termination, of several severely 

underfunded pension plans. In 1992, we reported that many factors 

contributed to the degree plans were underfunded at termination, 

including the payment at termination of additional benefits, such as 

subsidized early retirement benefits, which have been promised to plan 

participants if plants or companies ceased operations.13 These factors 

likely contributed to the degree that plans terminated in 2002 were 

underfunded. Factors that increased the severity of the plans’ unfunded 

liability in 2002 were the recent sharp decline in the stock market and a 

general decline in interest rates. 

In many cases, sponsors did not make the contributions necessary to 

adequately fund the plans before they were terminated. For example, 

according to annual reports (Annual Return/Report of Employee Benefit 

Plan, Form 5500) submitted by Bethlehem Steel Corporation, in the 7 years 

from 1992 to 1999, the Bethlehem Steel pension plan went from 86 percent 

funded to 97 percent funded. (See fig. 3.) From 1999 to plan termination in 

December 2002, however, plan funding fell to 45 percent as assets 

decreased and liabilities increased, and sponsor contributions were not 

sufficient to offset the changes. According to a survey,14 the Bethlehem 

Steel defined-benefit plan had about 73 percent of its assets (about $4.3 

billion of $6.1 billion) invested in domestic and foreign stocks on 

September 30, 2000. One year later, assets had decreased $1.5 billion, or 

25 percent, and when the plan was terminated in December 2002, its assets 

had been reduced another 23 percent to about $3.5 billion—far less than 

needed to finance an estimated $7.2 billion in PBGC-guaranteed 

liabilities.15 Surveys of plan investments by Greenwich Associates 

12See U.S. General Accounting Office, Pension Benefit Guaranty Corporation: SingleEmployer Pension Insurance Program Faces Significant Long-Term Risks, GAO-03-873T 

(Washington, D.C.: Sept. 4, 2003). 

13See U.S. General Accounting Office, Pension Plans: Hidden Liabilities Increase Claims 

Against Government Insurance Programs, GAO/HRD-93-7 (Washington, D.C.: Dec. 30, 

1992). 

14Pensions & Investments, vol. 29, Issue 2 (Chicago: Jan. 22, 2001). 

15According to the survey, the Bethlehem Steel Corporation’s pension plan made benefit 

payments of $587 million between Sept. 30, 2000, and Sept. 30, 2001. Pensions and 

Investments, www.pionline.com/pension/pension.cfm (downloaded on June 13, 2003). 

Page 7 GAO-04-176T 
indicated that defined-benefit plans in general had about 62.8 percent of 

their assets invested in U.S. and international stocks in 1999.16 

Figure 3: Assets, Liabilities, and Funded Status of the Bethlehem Steel Corporation 

Pension Plan, 1992-2002 

Dollars in billions Percent 

8.0 

7.0 

6.0 

5.0 

4.0 

3.0 

2.0 

1.0 

0 

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 

Assets 

Current liabilities 

Funded percentage 

Source: Annual Form 5500 reports and PBGC. 

120 

100 

80 

60 

40 

20 

0 

Note: Assets and liabilities for 1992 through 2001 are as of the beginning of the plan year. During that 

period, the interest rate Bethlehem Steel used to value current liabilities decreased from 9.26 percent 

to 6.21 percent. Assets and liabilities for 2002 are PBGC estimates at termination in December 2002. 

Termination liabilities were valued using a rate of 5 percent. 

These recent events and their consequences for PBGC’s finances have 

occurred in the context of the long-term stagnation of the defined-benefit 

system. The number of PBGC-insured plans has decreased steadily from 

approximately 110,000 in 1987 to around 30,000 in 2002.17 While the 

number of total participants in PBGC-insured single-employer plans has 

grown approximately 25 percent since 1980, participation has declined as 

162002 U.S. Investment Management Study, Greenwich Associates, Greenwich, Conn. 

17In contrast, defined-contribution plans have grown significantly over a similar period— 

from 462,000 plans in 1985 to 674,000 plans in 1998. 

Page 8 GAO-04-176T 
a percentage of the private sector labor force. Further, the percentage of 

participants who are active workers has declined from 78 percent in 1980 

to 53 percent in 2000. Manufacturing, a sector with virtually no job growth 

in the last half-century, accounted for almost half of PBGC’s singleemployer program participants in 2001, suggesting that the program needs 

to rely on other sectors for any growth in premium income. Unless 

something reverses these trends, PBGC may have a shrinking plan and 

participant base to support the program in the future as well as the 

likelihood of a participant base concentrated in certain, potentially more 

vulnerable industries. 

Minimum Funding Rules 

Did Not Prevent Plans 

from Being Severely 

Underfunded 

Internal Revenue Code (IRC) minimum funding rules, which are designed 

to ensure plan sponsors adequately fund their plans, did not have the 

desired effect for the terminated plans that were added to the singleemployer program in 2002. The amount of contributions required under 

IRC minimum funding rules is generally the amount needed to fund 

benefits earned during that year plus that year’s portion of other liabilities 

that are amortized over a period of years.18 Also, the rules require the 

sponsor to make an additional contribution if the plan is underfunded to 

the extent defined in the law. Under the additional funding requirement 

rule, a single-employer plan sponsored by an employer with more than 

100 employees in defined-benefit plans is subject to a deficit reduction 

contribution for a plan year if the value of plan assets is less than 

90 percent of its current liability. However, a plan is not subject to the 

deficit reduction contribution if the value of plan assets (1) is at least 

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

liability for each of the 2 immediately preceding years or each of the 

second and third immediately preceding years. To determine whether the 

additional funding rule applies to a plan, the IRC requires sponsors to 

calculate current liability using the highest interest rate allowable for the 

plan year.19 

In 1987, the minimum funding rules incorporated by ERISA in the IRC 

were amended to require that plan sponsors calculate each plan’s current 

18Minimum funding rules permit certain plan liabilities, such as past service liabilities, to be 

amortized over specified time periods. See 26 U.S.C. 412(b)(2)(B). Past service liabilities 

occur when benefits are granted for service before the plan was set up or when benefit 

increases after the set up date are made retroactive. 

19See 26 U.S.C. 412(l)(9)(C). 

Page 9 GAO-04-176T 
liability, using a discount rate based on the 30-year Treasury bond rate, 

and to use that calculation to assess the plan’s funding level.20 If plans are 

funded below certain thresholds as defined in the IRC, employers are to 

determine minimum contribution amounts on the basis of those 

assessments. Employers must make additional contributions to the plan if 

it is underfunded to extent defined in the law.21 If a plan is fully funded as 

defined in the law, employers are precluded from making additional taxdeductible contributions to the plan. In 2002, the Congress acted to 

provide temporary relief to DB plan sponsors by raising the top of the 

permissible range of the mandatory interest rate.22 As discussed in a report 

we issued earlier this year,23 concerns that the 30-year Treasury bond rate 

no longer resulted in reasonable current liability calculations has led both 

20Under the IRC, current liability means all liabilities to employees and their beneficiaries 

under the plan. See 26 U.S.C. 412(l)(7)(A). In calculating current liabilities, the IRC requires 

plans to use an interest rate from within a permissible range of rates. See 26 U.S.C. 

412(b)(5)(B). In 1987, the permissible range was not more than 10 percent above, and not 

more than 10 percent below, the weighted average of the rates of interest on 30-year 

Treasury bond securities during the 4-year period ending on the last day before the 

beginning of the plan year. The top of the permissible range was gradually reduced by 1 

percent per year beginning with the 1995 plan year to not more than 5 percent above the 

weighted average rate effective for plan years beginning in 1999. The weighted average rate 

is calculated as the average yield over 48 months with rates for the most recent 12 months 

weighted by 4, the second most recent 12 months weighted by 3, the third most recent 12 

months weighted by 2, and the fourth weighted by 1. 

21Under the additional funding requirement rule, a single-employer plan sponsored by an 

employer with more than 100 employees in defined-benefit plans is subject to a deficit 

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

its current liability. However, a plan is not subject to the deficit reduction contribution if 

the value of plan assets (1) is at least 80 percent of current liability and (2) was at least 90 

percent of current liability for each of the 2 immediately preceding years or each of the 

second and third immediately preceding years. To determine whether the additional 

funding rule applies to a plan, the IRC requires sponsors to calculate current liability using 

the highest interest rate allowable for the plan year. See 26 U.S.C. 412(l)(9)(C). 

22The top of the permissible range of the 30-year Treasury rate for determining a plan’s 

current liability was temporarily increased to 20 percent above the weighted average rate 

for 2002 and 2003. This temporary measure expires at the end of 2003. 

23See U.S. General Accounting Office, Private Pensions: Process Needed to Monitor the 

Mandated Interest Rate for Pension Calculations, GAO-03-313 (Washington, D.C.: Feb. 27, 

2003). 

Page 10 GAO-04-176T 
Congress and the administration to propose alternative rates for these 

calculations.24 

While minimum-funding rules may encourage sponsors to better fund their 

plans, plans can earn funding credits, which can be used to offset 

minimum funding contributions in later years, by contributing more than 

required according to minimum funding rules. Therefore, sponsors of 

underfunded plans may avoid or reduce minimum funding contributions to 

the extent their plan has a credit balance in the account, referred to as the 

funding standard account, used by plans to track minimum funding 

contributions.25 

Additionally, the rules require sponsors to assess plan funding using 

current liabilities, which a PBGC analysis indicates have been typically 

less than termination liabilities.26 A plan’s termination liability measures 

the value of accrued benefits using assumptions appropriate for a 

terminating plan, while its current liability measures the value of accrued 

benefits using assumptions specified in applicable laws and regulations. 

Current and termination liabilities differ because the assumptions used to 

calculate them differ. Interest rates are a key assumption in calculating the 

present value of future pension benefits: while all sponsors calculate 

current liabilities using a rate based on the 30-year Treasury bond rate, 

ERISA requires sponsors of some underfunded plans to report plan 

termination liability information to PBGC. These sponsors calculate 

termination liability using a rate published by PBGC, based on surveys of 

24Recently, the U.S. House of Representatives passed the Pension Funding Equity Act (H.R. 

3108), which replaces the 30-year Treasury rate with a blend of corporate bond index rates 

for 2 years through 2005. In July of 2003, the Department of the Treasury unveiled The 

Administration Proposal to Improve the Accuracy and Transparency of Pension 

Information. The proposal’s stated purpose is to improve the accuracy of the pension 

liability discount rate, increase the transparency of pension plan information, and 

strengthen safeguards against pension underfunding. 

25See 26 U.S.C. 412(b). 

26For the analysis, PBGC used termination liabilities reported to it under 29 C.F.R. sec 4010. 

Page 11 GAO-04-176T 
insurance companies performed by the American Council of Life 

Insurers.27 

Other aspects of minimum funding rules may limit their ability to affect the 

funding of certain plans as their sponsors approach bankruptcy. According 

to its annual reports, for example, Bethlehem Steel contributed about $3.0 

billion to its pension plan for plan years 1986 through 1996. According to 

the reports, the plan had a credit balance of over $800 million at the end of 

plan year 1996. Starting in 1997, Bethlehem Steel reduced its contributions 

to the plan and, according to annual reports, contributed only about $71.3 

million for plan years 1997 through 2001. The plan’s 2001 actuarial report 

indicates that Bethlehem Steel’s minimum required contribution for the 

plan year ending December 31, 2001, would have been $270 million in the 

absence of a credit balance; however, the opening credit balance in the 

plan’s funding standard account as of January 1, 2001, was $711 million. 

Therefore, Bethlehem Steel was not required to make any contributions 

during the year. 

Other IRC funding rules may have prevented some sponsors from making 

contributions to plans that in 2002 were terminated at a loss to the singleemployer program. For example, on January 1, 2000, the Polaroid pension 

plan’s assets were about $1.3 billion compared to accrued liabilities of 

about $1.1 billion—the plan was more than 100 percent funded. The plan’s 

actuarial report for that year indicates that the plan sponsor was 

precluded by IRC funding rules from making a tax-deductible contribution 

to the plan.28 In July 2002, PBGC terminated the Polaroid pension plan, and 

the single-employer program assumed responsibility for $321.8 million in 

unfunded PBGC-guaranteed liabilities for the plan. The plan was about 67 

percent funded, with assets of about $657 million to pay estimated PBGCguaranteed liabilities of about $979 million. 

27Sponsors are required to provide PBGC with termination liability information if, among 

other things, the aggregate unfunded vested benefits at the time of the preceding plan year 

of plans maintained by the contributing sponsor and the members of its controlled group 

exceed $50 million, disregarding plans with no unfunded benefits. See 29 U.S.C. 1310(b). 

Among the information to be provided to PBGC is the value of benefit liabilities determined 

using the assumptions applicable to the valuation of benefits to be paid as annuities in 

trusteed plans terminating at the end of the plan year. See 29 C.F.R. 4010.8(d)(2). 

28See 26 U.S.C. 404(a)(1) and 26 U.S.C. 412(c)(7). The sponsor might have been able to 

make a contribution to the plan had it selected a lower interest rate for valuing current 

liabilities. Polaroid used the highest interest rate permitted by law for its calculations. 

Page 12 GAO-04-176T 
Strengthening Plan 

Funding Rules Can 

Help Sponsors 

Maintain Well-Funded 

Plans 

Several types of reforms might be considered to improve the funding of 

defined-benefit pension plans. Some options for reform would directly 

address funding requirements and related rules. Funding rules could be 

revised to require increased minimum contributions to underfunded plans 

and to allow additional contributions to fully funded plans. This approach 

would improve plan funding over time and improve the security of 

workers’ benefits, while limiting the losses PBGC would incur when a plan 

is terminated. Such a change would require some sponsors to allocate 

additional resources to their pension plans, which may cause the plan 

sponsor of an underfunded plan to provide less generous wages or 

benefits than would otherwise be provided. Also, such funding rule 

changes could take years to have a meaningful effect on PBGC’s financial 

condition. As examples of such funding rule revisions, the IRC could be 

amended to: 

• 	 Base Additional Funding Requirement and Maximum TaxDeductible Contributions on Plan Termination Liabilities, Rather 

than Current Liabilities. Since plan termination liabilities typically 

exceed current liabilities, such a change regarding deficit reduction 

contributions would likely improve plan funding and, therefore, reduce 

potential claims against PBGC. One potential problem with this approach 

is the difficulty plan sponsors would have in determining the appropriate 

interest rate to use in valuing termination liabilities. As we reported, 

selecting an appropriate interest rate for termination liability calculations 

is difficult because little information exists on which to base the 

selection.29 

• 	 Change Requirements For Making Additional Funding 

Contributions. IRC requires sponsors to make additional contributions 

under two circumstances: (1) if the value of plan assets is less than 80 

percent of its current liability or (2) if the value of plan assets is less than 

90 percent of its current liability, depending on plan funding levels for the 

previous 3 years. Raising the threshold would require more sponsors of 

underfunded plans to make the additional contributions. 

• 	 Limit the Use of Credit Balances by Severely Underfunded Plans to 

Avoid Additional Contributions. For sponsors who make contributions 

in any given year that exceed the minimum required contribution, the 

excess plus interest is credited against future required contributions. 

Limiting the use of credit balances to offset contribution requirements 

29GAO-03-313. 

Page 13 GAO-04-176T 
might also prevent sponsors of significantly underfunded plans from 

avoiding cash contributions. For example, in the absence of a credit 

balance, Bethlehem Steel would have been due to pay at least $270 million 

to its pension plan for the plan year ending December 31, 2001; however, 

because it showed a credit balance of $711 million as of January 1, 2001, 

Bethlehem was not required to make any cash contributions for that year. 

Limitations might also be applied based on the plan sponsor’s financial 

condition. For example, sponsors with poor cash flow or low credit ratings 

could be restricted from using their credit balances to reduce their 

contributions. 

• 	 Limit Lump-Sum Distributions by Plans That Are Significantly 

Underfunded. Defined-benefit pension plans may offer participants the 

option of receiving their benefit in a lump-sum payment. Allowing 

participants to take lump-sum distributions from severely underfunded 

plans, especially those sponsored by financially weak companies, allows 

the first participants who request a distribution to drain plan assets, which 

might result in the remaining participants receiving reduced payments 

from PBGC if the plan terminates.30 A “tiered system” may be set up 

whereby a plan that does not meet a certain funding ratio threshold might 

be prohibited from allowing highly compensated employees from taking 

benefits as lump sums; below a lower funding ratio threshold, lump-sum 

withdrawals for all employees might be prohibited. However, the payment 

of lump sums by underfunded plans may not directly increase losses to the 

single employer program because lump sums reduce plan liabilities as well 

as plan assets. 

• 	 Raise the Level of Tax-Deductible Contributions. IRC and ERISA 

restrict tax-deductible contributions to prevent plan sponsors from 

contributing more to their plan than is necessary to cover accrued future 

benefits.31 This can prevent employers from making plan contributions 

during periods of strong profitability. Raising these limitations might result 

30The administration’s proposal would require companies with below investment grade 

credit ratings whose plans are less than 50 percent funded on a termination basis to 

immediately fully fund or secure any new benefit improvements, benefit accruals, or lump 

sums. 

31Employers are generally subject to an excise tax for failure to make required 

contributions or for making contributions in excess of the greater of the maximum 

deductible amount or the ERISA full-funding limit. 

Page 14 GAO-04-176T 
in pension plans being better funded, decreasing the likelihood that they 

will be underfunded should they terminate.32 

• 	 Expand Restrictions on Unfunded Benefit Increases. Currently, plan 

sponsors must meet certain conditions before increasing the benefits of 

plans that are less than 60 percent funded.33 Increasing this threshold, or 

restricting benefit increases or accruals when plans reach the threshold, 

could decrease the losses incurred by PBGC from underfunded plans. One 

disadvantage is that it could result in lower pension benefits for affected 

workers. In addition, plan sponsors have said that the disadvantage of 

such changes is that they would limit an employer’s flexibility with regard 

to setting compensation, making it more difficult to respond to labor 

market developments. For example, a plan sponsor might prefer to offer 

participants increased pension payments or shutdown benefits instead of 

offering increased wages because pension benefits can be deferred— 

providing time for the plan sponsor to improve its financial condition— 

while wage increases have an immediate effect on the plan sponsor’s 

financial condition. 

• 	 Improve Funding of Shutdown Benefits. Shutdown benefits provide 

significant early retirement benefit subsidies or other benefits offered to 

participants affected by a plant closing or a permanent layoff. Such 

benefits are primarily found in the pension plans of large unionized 

companies in the auto, steel, and tire industries. In general, shutdown 

benefits cannot be adequately funded before a shutdown occurs. Rules 

could mandate accelerated funding of shutdown benefits after they go into 

effect. However, if a plant shutdown coincides with the bankruptcy of a 

company and the termination of the pension plan, it may be impossible for 

the bankrupt sponsor to fund these benefits. 

In addition to funding rules, plan sponsors need an accurate funding 

“target” that provides enough funding to pay promised current and future 

benefits while not leading sponsors to “overfund” their pension plans, 

32For example, one way to do this would be to allow deductions within a corridor of up to 

130 percent of current liabilities. Gebhardtsbauer, Ron. American Academy of Actuaries 

testimony before the Subcommittee on Employer-Employee Relations, House Committee 

on Education and the Workforce, Hearing on Strengthening Pension Security: Examining 

the Health and Future of Defined-benefit Pension Plans. (Washington, D.C.: June 4, 2003), 

9. 

33IRC provides generally that a plan less than 60 percent funded on a current liability basis 

may not increase benefits without either immediately funding the increase or providing 

security. See 26 U.S.C. 401(a)(29). 

Page 15 GAO-04-176T 
siphoning resources from other productive firm specific activities. The 

interest rate sponsors use to determine plan liabilities can affect this target 

and, therefore, plan funding. In 1987, when the 30-year Treasury bond rate 

was adopted for use in certain pension calculations, the Congress intended 

that the interest rate used for current liability calculations would, within 

certain parameters, reflect the price an insurance company would charge 

to take responsibility for the plan’s pension payments. However, selecting 

a replacement rate that will provide an accurate funding target may be 

difficult because little information exists on which to base the selection. 

In taking action to replace the 30-year Treasury bond rate, it is important 

to consider the impact that any change may have on funding. If Congress 

mandates the use of a rate that is “too high,” plans are more likely to 

appear better funded, but minimum and maximum employer contributions 

would decrease, possibly increasing the likelihood of plan underfunding. 

In addition, some plans would reach full-funding limitations and avoid 

having to pay variable-rate premiums, and PBGC would receive less 

revenue. Conversely, a rate that is “too low” would make plans appear 

worse funded, with more plans likely to increase contributions and 

possibly pay variable-rate premiums. Thus, it may well be prudent for 

Congress to make any provision replacing the 30-year Treasury bond rate 

temporary to facilitate more comprehensive funding reform to take shape. 

In addition to direct changes to the funding rules, other reforms may result 

in improved plan funding by improving incentives for sponsors to maintain 

proper funding in their plans. These measures may prevent plans from 

terminating with severely underfunded balances, thus better protecting 

workers, retirees, and PBGC. For example, improving the availability of 

information to plan participants and others about plan investments, 

termination funding status, and PBGC guarantees may give plan sponsors 

additional incentives to better fund their plans, making participants better 

able to plan for their retirement. The restructuring of PBGC’s premium 

34Other than a survey conducted for PBGC, no mechanism exists to collect information on 

actual group annuity purchase rates. Compared to other alternatives, the PBGC interest 

rate factors may have the most direct connection to the group annuity market, but PBGC 

factors are less transparent than market-determined alternatives. Long-term market rates 

may track changes in group annuity rates over time, but their proximity to group annuity 

rates is uncertain. For example, an interest rate based on a long-term market rate, such as 

corporate bond indexes, may need to be adjusted downward to better reflect the level of 

group annuity purchase rates. However, as we stated in our report earlier this year, 

establishing a process for regulatory adjustments to any rate selected may make it more 

suitable for pension plan liability calculations. See GAO-03-313. 

Other Reforms Might 

Enhance Sponsor 

Incentives to Maintain 

Plan Funding 

Page 16 GAO-04-176T 

34 
rates could also provide an incentive for plan sponsors to better fund their 

plans. It is also possible that basing changes to premium rates on the 

degree of risk posed by different plans may encourage financially healthy 

companies to remain in or enter the defined-benefit system while 

discouraging riskier plan sponsors. Moreover, it may be appropriate to 

consider modifying certain benefit guarantees that could decrease losses 

incurred by PBGC from underfunded plans. ERISA could be amended to: 

• 	 Require Greater Disclosure of Information on Plan Investments. 

Some information on the allocation of plan investments among asset 

classes—such as equity or fixed income—may be available from Form 

5500s prepared by plan sponsors, but that information is not readily 

accessible to participants and beneficiaries. Additionally, some plan 

investments may be made through common and collective trusts, master 

trusts, and registered investment companies, and asset allocation 

information for these investments might need to be obtained from Form 

5500s prepared by those entities or from their prospectuses. As such, 

improving the availability of plan asset allocation information to 

participants may give plan sponsors an incentive to increase funding of 

underfunded plans or limit riskier investments. Moreover, only 

participants in plans below a certain funding threshold receive annual 

notices regarding the funding status of their plans, and the information 

plans must currently provide does not reflect how the plan’s assets are 

invested. One way to enhance notices provided to participants could be to 

include information on how much of plan assets are invested in the 

sponsor’s own securities.35 This would be of concern because should the 

sponsor become bankrupt, the value of the securities could be expected to 

drop significantly, reducing plan funding. Although this information is 

currently provided in the plan’s Form 5500, it is not readily accessible to 

participants. Additionally, if the defined-benefit plan has a floor-offset 

arrangement and its benefits are contingent on the investment 

performance of a defined-contribution plan, then information provided to 

participants could also disclose how much of that defined-contribution 

plan’s assets are invested in the sponsor’s own securities. 

• 	 Require Greater Disclosure of Plan Termination Funding Status. 

Under current law, sponsors are required to report a plan’s current liability 

for funding purposes, which often can be lower than termination liability. 

35Although ERISA permits plan sponsors to invest plan assets in employer stock, definedbenefit plans may not acquire any qualified employer security or real property if 

immediately after the acquisition the aggregate fair market value of such assets exceeds 10 

percent of the fair market value of the plan’s total assets. 

Page 17 GAO-04-176T 
In addition, only participants in plans below a certain funding threshold 

receive annual notices of the funding status of their plans.36 As a result, 

many plan participants, including participants of the Bethlehem Steel 

pension plan, did not receive such notifications in the years immediately 

preceding the termination of their plans. Expanding the circumstances 

under which sponsors must notify participants of plan underfunding might 

give sponsors an additional incentive to increase plan funding and would 

enable more participants to better plan their retirement. Under the 

Administration’s proposal, all sponsors would be required to disclose the 

value of pension plan assets on a termination basis in their annual 

reporting. The Administration proposes that all companies disclose the 

value of their defined-benefit pension plan assets and liabilities on both a 

current liability and termination liability basis in their Summary Annual 

Report (SAR).37 

• 	 Increase or Restructure Variable-Rate Premium. PBGC charges plan 

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

underfunding, premiums, with sponsors paying $9 per $1,000 of unfunded 

liability. However, the recent terminations of Bethlehem Steel, Anchor 

Glass, and Polaroid, plans that paid no variable-rate premiums shortly 

before terminating with large underfunded balances, suggest that the 

current structure of the variable-rate premium does not provide a strong 

enough incentive to improve plan funding or is too easily avoidable. The 

rate could be adjusted so that plans with less adequate funding pay a 

higher rate. In addition, premium rates could be restructured based on the 

degree of risk posed by different plans, which could be assessed by 

considering the financial strength and prospects of the plan’s sponsor, the 

risk of the plan’s investment portfolio, participant demographics, and the 

plan’s benefit structure—including plans that have lump-sum,38 shutdown 

36The ERISA requirement that plan sponsors notify participants and beneficiaries of the 

plan’s funding status and limits on the PBGC guarantee currently goes into effect when 

plans are required to pay variable-rate premiums and meet certain other requirements. See 

29 U.S.C. 1311 and 29 C.F.R. 4011.3. 

37Participants and individuals receiving benefits from their plan must receive a Summary 

Annual Report (SAR) from their plan’s administrator each year. The SAR summarizes the 

plan’s financial status based on information that the plan administrator provides to the 

Department of Labor on its annual Form 5500. This document must generally be provided 

no later than nine months after the close of the plan year. 

38For example, a plan that allows a lump-sum option—as is often found in a cash-balance 

and other hybrid plan—may pose a different level of risk to PBGC than a plan that does 

not. 

Page 18 GAO-04-176T 
benefit, and floor-offset provisions.39 One advantage of a rate increase or 

restructuring is that it might improve accountability by providing for a 

more direct relationship between the amount of premium paid and the risk 

of underfunding. A disadvantage is that it could further burden already 

struggling plan sponsors at a time when they can least afford it, or it could 

reduce plan assets, increasing the likelihood that underfunded plans will 

terminate. A program with premiums that are more risk-based could also 

be more challenging for PBGC to administer. 

• 	 Phase-in the Guarantee of Shutdown Benefits. PBGC is concerned 

about its exposure to the level of shutdown benefits, or benefit increases 

that are unfunded at termination.40 PBGC could phase-in the guarantee of 

such benefits. Similar to benefit increases prior to termination, the agency 

could perhaps guarantee an additional 20 percent of shutdown benefits 

each year after the benefits are offered, with full benefits (up to PBGC 

limits) guaranteed only after 5 years. Phasing in guarantees from the date 

of the applicable shutdown could decrease the losses incurred by PBGC 

from underfunded plans.41 A phase-in might cause workers to put pressure 

on sponsors to fund these benefits or benefit increases, or demand 

alternative forms of compensation. Modifying these benefits would reduce 

the early retirement benefits for participants who are in plans with such 

provisions and are affected by a plant closing or a permanent layoff. 

Dislocated workers, particularly in manufacturing, may suffer additional 

losses from lengthy periods of unemployment or from finding 

reemployment only at much lower wages. 

39Under the floor-offset arrangement, the benefit computed under the final pay formula is 

“offset” by the benefit amount that the account of another plan, such as an Employee Stock 

Ownership Plan, could provide. 

40PBGC guarantees benefits up to certain limits. PBGC may pay only a portion of the claim 

because ERISA places limits on the PBGC benefit guarantee. For example, PBGC generally 

does not guarantee annual benefits above a certain amount, currently about $44,000 per 

participant at age 65. Additionally, benefit increases in the 5 years immediately preceding 

plan termination are not fully guaranteed, though PBGC will pay a portion of these 

increases. The guarantee does not generally include supplemental benefits, such as the 

temporary benefits that some plans pay to participants from the time they retire until they 

are eligible for Social Security benefits. 

41Currently, some measures exist to limit the losses incurred by PBGC from certain 

terminated plans. PBGC is responsible for only a portion of all benefit increases that the 

sponsor adds in the 5 years leading up to termination. 

Page 19 GAO-04-176T 
Conclusion 
 Widespread underfunding in the defined-benefit pension system 

potentially threatens the retirement security of millions of American 

workers. The termination of severely underfunded plans can significantly 

reduce the benefits promised to workers and retirees. It also threatens the 

solvency of PBGC’s single-employer insurance program, with, in the worse 

case, Congress facing the choice of a bailout or of letting affected workers 

and retirees lose the pension benefits they depend on. While the pension 

system does not face an immediate crisis, these serious financial 

challenges suggest that meaningful, if perhaps difficult, comprehensive 

action needs to be taken. Such action would be aimed towards the 

improvement of the long-term funding status of plans and the 

accountability of plan sponsors, especially those that represent a clear risk 

to PBGC, plan participants, and their beneficiaries. 

Undoubtedly, unfavorable economic conditions have contributed to 

widespread underfunding and conspired to place well-meaning sponsors 

in very difficult positions to maintain their plans’ funding. Although 

comprehensive reform should include improving plan funding as the key 

vehicle to stabilize and enhance the long-term health of the defined-benefit 

system, Congress may seek to balance improvements in funding and 

accountability against the short-term needs of some sponsors who may 

have difficulty making contributions to their plans. Relief measures should 

be carefully targeted to those sponsors that may need it most urgently, 

with some provision for this aid to eventually lead to improved plan 

funding. In crafting this reform, the Congress should be wary of temporary 

rule changes directed exclusively to short-term problems that could 

increase the risk that plans terminate in even worse financial straits than 

they suffer today. 

It is important to keep in mind that the factors contributing to the 

deterioration of pension plan funding go beyond the effects of the recent 

economic downturn. The defined-benefit system has shown signs of 

stagnation for the past 2 decades, with a steady decline in the number of 

plans and a decreasing proportion of working participants. PBGC’s 

participant base may also be concentrated in more vulnerable industries. 

Concerns about PBGC’s long-run financial viability, and not just the recent 

alarming jump in its accumulated deficit, prompted us to put the singleemployer program on our high-risk list. While it is unlikely that any rules 

can guarantee that all plans are fully funded at all times, nor should that be 

their goal, regulations should strive to maintain the overall health of the 

system and prevent poor economic conditions from creating a general 

funding crisis. 

Page 20 GAO-04-176T 
In addition to the administration’s current proposal, the Treasury 

Department, Labor Department, and PBGC are considering reforms that 

seek to address many of these issues and include elements of the options 

that I have identified in my testimony, such as increased transparency for 

plan participants. The private defined-benefit pension system is at a 

crossroads, facing a threat of continued financial erosion and decline. 

However, we also have the opportunity and the challenge to broadly move 

the system back to a solid, stable financial footing that will provide needed 

retirement benefits to workers and retirees for decades to come. 

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

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

For information regarding this testimony, please contact Barbara D. 

Bovbjerg, Director, Education, Workforce, and Income Security Issues, on 

(202) 512-7215 or Charles A. Jeszeck on (202) 512-7036. Individuals who 

made key contributions to this testimony are Mark M. Glickman, 

Jeremy Citro, Daniel F. Alspaugh, and John M. Schaefer. 

(130334) Page 21 GAO-04-176T 
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