a

GAO

United States General Accounting Office

Report to Congressional Committees

November 2003 POSTAL PENSION 

FUNDING REFORM

Issues Related to the 

Postal Service’s 

Proposed Use of 

Pension Savings

GAO-04-238
www.gao.gov/cgi-bin/getrpt?GAO-04-238.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Bernard L. 

Ungar at (202) 512-2834 or ungarb@gao.gov. 

Highlights of GAO-04-238, a report to 

congressional committees 

November 2003 

POSTAL PENSION FUNDING REFORM 

Issues Related to the Postal Service’s 

Proposed Use of Pension Savings 

The Service’s report presented two proposals for how it would use the 

“savings,” and GAO found both to be generally consistent with P.L. 108-18. 

The first proposal assumes that responsibility for military service pension 

costs shifts to the Treasury Department and proposes prefunding retiree 

health benefits for retirees and current employees. The second proposal 

assumes that the Service retains responsibility for military service pension 

costs and proposes prefunding retiree health benefits only for new 

employees. Both proposals assume that the Service would pay down debt 

and fund capital investment through inflation-based rate increases. 

Under both proposals, the Service proposes that the escrow requirement be 

eliminated, so that the Service would not have to include $3 billion as a 

mandated incremental operating expense beginning in fiscal year 2006. The 

Service cannot use the escrow funds unless Congress eliminates the escrow 

requirement or specifies by law how these funds may be used. If no action is 

taken, the Service believes that it would have to raise rates higher than 

would otherwise be necessary. The escrow requirement provides Congress 

an opportunity to review how the Postal Service will address a number of 

long-term challenges, such as progress toward transformation and funding 

its retiree health benefits obligation. Once Congress is satisfied, it could 

repeal the escrow requirement so that an escrow account is not needed. 

GAO assessed the Service’s two proposals according to their fairness, 

affordability, and the ability to achieve transformation goals, as follows: 

Fairness: Proposal I strikes a more equitable balance of allocating costs 

between current and future ratepayers, because benefits earned by today’s 

employees will be built into the current rate base. Under Proposal II, much 

of the retiree health benefits obligation would remain unfunded, thereby 

placing the burden of the benefits being earned today on future ratepayers. 

Affordability: The Service’s proposals attempt to balance short-term rate 

mitigation with some level of prefunding to address its long-term obligations. 

The first proposal would require a larger postal rate increase than the 

second proposal and would prefund more of the retiree health benefits. The 

second proposal focuses more on rate mitigation. Given the Service’s 

uncertain financial future, its ability to raise revenues, reduce costs, and 

improve productivity and efficiency is critical to affordability. 

Transformation goals: Although the Service believes it can pay down debt 

and fund the capital investments associated with its transformation 

initiatives, this is not clear because the Service has not yet presented a 

comprehensive, integrated infrastructure and workforce rationalization plan. 

GAO has previously recommended that the Service provide Congress with 

such a plan and periodic reports on its transformation progress. The Service 

disagrees with GAO that the escrow repeal should be tied to a plan. 

In April 2003, Congress enacted the 

Postal Civil Service Retirement 

System (CSRS) Funding Reform 

Act of 2003 (P.L. 108-18), which 

lowered the Postal Service’s 

(Service) annual payment for its 

CSRS obligation by over $2.5 billion

beginning in fiscal year 2003. P.L. 

108-18 includes requiring (1) the 

Service to begin making payments 

into an escrow account in fiscal 

year 2006, (2) the Service to issue a 

report on its proposed use of 

“savings” resulting from the lower 

CSRS payments, and (3) GAO to 

evaluate the Service’s report and 

present its findings to Congress. 

GAO evaluated whether the 

Service’s proposals were consistent 

with P.L. 108-18; the impact of the 

escrow account; and whether the 

proposals were fair to current and 

future ratepayers, affordable, and 

helped achieve transformation 

goals. 

To ensure continuing progress in 

addressing the Service’s financial 

challenges, Congress should 

consider repealing the escrow 

requirement after it receives an 

acceptable plan on rationalizing the 

Service’s infrastructure and 

workforce. Absent an acceptable 

plan, Congress could direct the 

Service to fund specific purposes, 

such as prefunding its retiree 

health benefits obligation or 

supporting the Service’s 

transformation. GAO makes 

additional matters for Congress to 

consider in the report. 
Page i GAO-04-238 Postal Pension Funding Reform

Contents

Letter 1

Results in Brief 4

Background 9

Both Proposals Are Generally Consistent with P.L. 108-18 10

Escrow Requirement Places Pressure on Rates 12

Key Issues Used to Assess the Postal Service’s Proposals 14

Issues Related to the Implementation of Proposals I and II 24

Conclusions 29

Matters for Congressional Consideration 30

Agency Comments and Our Evaluation 31

Appendixes

Appendix I: Objectives, Scope, and Methodology 34

Appendix II: Comments from the U.S. Postal Service 36

Appendix III: GAO Contact and Staff Acknowledgments 38

GAO Contact 38

Staff Acknowledgments 38

Table Table 1: Estimated Debt Repayment and Capital Investment under 

Proposal II 22

Figures Figure 1: Additional Expense Generated from Proposal I 19

Figure 2: Comparison of Retiree Health Premiums and “Savings” 

under Proposal II 20
Contents

Page ii GAO-04-238 Postal Pension Funding Reform

Abbreviations

CBO Congressional Budget Office

CSRS Civil Service Retirement System

CSRDF Civil Service Retirement and Disability Fund

FASB Financial Accounting Standards Board

OPM Office of Personnel Management

PRC Postal Rate Commission

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Page 1 GAO-04-238 Postal Pension Funding Reform

United States General Accounting Office

Washington, D.C. 20548

Comptroller General A of the United States

November 26, 2003 Letr

The Honorable Susan M. Collins

Chairman 

The Honorable Joseph I. Lieberman

Ranking Minority Member

Committee on Governmental Affairs

United States Senate

The Honorable Tom Davis

Chairman

The Honorable Henry A. Waxman

Ranking Minority Member

Committee on Government Reform

House of Representatives

The Postal Service (Service) faces significant financial challenges, 

including declining mail volume, the need to fund productivity 

improvement and cost saving initiatives necessary to transform itself into a 

more efficient organization, and a growing obligation for retiree health 

benefits that the Service estimated will reach $54 billion by the end of fiscal 

year 2003. In April 2003, Congress enacted the Postal Civil Service 

Retirement System (CSRS) Funding Reform Act of 2003 (P.L. 108-18), 

which afforded the Service the opportunity to address some of these 

challenges by lowering the annual payment the Service is required to make 

into the Civil Service Retirement & Disability Fund (CSRDF) by over $2.5 

billion annually beginning in fiscal year 2003. The legislation specified how 

these savings were to be used for fiscal years 2003-2005. It also required the 

Service to begin making payments into an escrow account beginning in 

fiscal year 2006 in an amount equal to the difference between the estimated 

CSRS payments prior to, and after, enactment of the legislation. The 

amount of the payments into the escrow account would have to be 

included in the Service’s rate base. Under the legislation, the Service 

cannot use the funds in the escrow account unless Congress eliminates the 

escrow requirement or specifies by law how the escrow funds may be used. 

In our view, this escrow requirement provides Congress an opportunity to 

review how the Service will address a number of long-term challenges, 

including debt repayment, capital projects, and its unfunded retiree health 

benefits obligation. The legislation also required the Service to report by 

September 30, 2003, on how it proposes to use these pension savings and 

required GAO to evaluate the Service’s submission and present our findings
Page 2 GAO-04-238 Postal Pension Funding Reform

to the appropriate oversight committees.1 The legislation states that not 

later than 180 days after receiving our report, the Congress shall revisit the 

issue of how the savings accruing to the Service as a result of enactment of 

the legislation should be used. 

P.L. 108-18 also transferred responsibility for CSRS pension benefits 

attributable to military service in the amount of $27 billion from the 

Department of the Treasury (Treasury) to the Postal Service. The law 

required the Service, the Office of Personnel Management (OPM), and the 

Treasury to prepare reports by September 30, 2003, articulating who should 

be responsible for these costs in the future.2

 The Postal Service’s report on 

this issue recommended that the responsibility for military service costs be 

transferred back to the Treasury. However, the joint report of Treasury and 

OPM recommended that the Postal Service should be responsible (1) for all 

pension costs related to military service for its employees that were hired 

after the Service’s reorganization in 1971 and (2) for a portion of the 

military service costs for employees hired before 1971. Further, the 

legislation required GAO to review these reports and submit our findings to 

the appropriate oversight committees, which we are providing in a separate 

report (GAO-04-281) also issued on this date.3

To guide the Service in its proposed use of pension-related savings 

beginning in fiscal year 2006, the legislation included specific “Matters to 

Consider” and a “Sense of Congress.” The “Matters to Consider” included 

the following matters: (i) debt repayment; (ii) prefunding of postretirement 

health care benefits for current and former postal employees; (iii) 

productivity and cost-saving capital investments; (iv) delaying or 

moderating increases in postal rates; and (v) any other matter. The “Sense 

of Congress” stated that

1

U.S. Postal Service, Postal Service Proposal: Use of Savings for Fiscal Years after 2005, 

P.L. 108-18, Sept. 30, 2003.

2

U.S. Postal Service, Postal Service Proposal: Military Service Payments Requirements,

P.L. 108-18, Sept. 30, 2003. Joint report by the Office of Personnel Management and the 

Department of the Treasury, Report to Congress on the Financing of Benefits Attributable 

to the Military Service of Current and Former Employees of the Postal Service, Sept. 30, 

2003.

3

U.S. General Accounting Office, Postal Pension Funding Reform: Review of Military 

Service Funding Proposals, GAO-04-281 (Washington, D.C.: Nov. 26, 2003).
Page 3 GAO-04-238 Postal Pension Funding Reform

• “the savings accruing to the Postal Service as a result of the enactment 

of this act will be sufficient to allow the Postal Service to fulfill its 

commitment to hold postage rates unchanged until at least 2006;

• because the Postal Service still faces substantial obligations related to 

postretirement health benefits for its current and former employees, 

some portion of the savings . . . should be used to address those 

unfunded obligations; and 

• none of the savings . . . should be used in the computation of any 

bonuses for Postal Service executives.”

In addition, the legislation stated that the Service should also consider the 

work of the President’s Commission on the United States Postal Service 

(the Commission), whose report, issued in July 2003, identified the need for 

the Service to operate more efficiently.4

 The Commission’s report 

recommended, among other things, that

• “the Service should review its current policy relating to the accounting 

treatment of retiree health care benefits, and work with its independent 

auditor to determine the most appropriate treatment of such costs in 

accordance with applicable accounting standards and in consideration 

of the Postal Service’s need for complete transparency in the reporting 

of future liabilities; 

• the Postal Service should consider funding a reserve account for 

unfunded retiree health care obligations to the extent that its financial 

condition allows; and

• responsibility for funding Civil Service Retirement System pension 

benefits relating to the military service of Postal Service retirees should 

be returned to the Department of the Treasury.”

The Service’s report on the use of the savings contained two proposals that 

are linked to the outcome of the military service issue. The first proposal 

(Proposal I) is predicated on the assumption that the Service is relieved of 

responsibility for military service costs and proposes that the Service 

4

President’s Commission on the United States Postal Service, Embracing the Future: 

Making the Tough Choices to Preserve Universal Mail Service, (Washington, D.C.: July 31, 

2003).
Page 4 GAO-04-238 Postal Pension Funding Reform

would prefund retiree health benefits for retirees and current employees. 

In its second proposal (Proposal II), the Service assumes that it retains 

responsibility for the military costs and proposes that it would prefund 

retiree health benefits only for new employees, pay down debt, and finance 

selected capital investments. The Service also stated that this proposal 

would have what the Service characterized as an “indirect benefit” of 

mitigating rate increases. By using most of the pension savings to fund 

normal operating expenses, the only additional rate increase needed would 

be a 0.3 percent increase over the rate of inflation to cover the prefunding 

for its new employees. 

This report addresses four objectives. First, it evaluates whether the Postal 

Service’s report on the use of the pension savings is consistent with P.L. 

108-18. Second, it evaluates the issues surrounding the impact of the 

escrow requirement that the Service identified in its report. Third, it 

assesses the Service’s two proposals according to the following questions, 

which are based upon our previous work:

• Are these proposals fair and balanced between current and future 

ratepayers and taxpayers? 

• Can the Service afford to do as it proposes in light of its financial 

challenges? 

• Do these proposals help promote and accelerate the Service’s 

transformation efforts, including related cost savings and productivity 

improvement efforts?

Finally, our report discusses other pertinent issues, such as how the 

proposals might be implemented, that we identified in the course of our 

review. Our work is based on our review of Postal Service documents, the 

report of the President’s Commission on the United States Postal Service, 

our prior reports, and interviews with officials at the Postal Service and the 

Congressional Budget Office (CBO). A more detailed discussion of our 

objectives, scope, and methodology is included in appendix I. We requested 

comments on a draft of this report from the Postal Service, and its 

comments are discussed later in this report and reproduced in appendix II.

Results in Brief Both proposals are generally consistent with the Sense of Congress 

expressed in P.L. 108-18 because they address, to varying degrees, 

prefunding the retiree health benefits obligation. They also address some of 
Page 5 GAO-04-238 Postal Pension Funding Reform

the Matters to Consider outlined in P.L. 108-18, including rate mitigation 

and, to a lesser degree, debt repayment and productivity and cost-saving 

capital investments. In addition, the proposals are generally consistent with 

the Commission’s recommendations and our previous work. In considering 

the Service’s proposals, we note that this legislation, by significantly 

reducing the Service’s pension costs, has provided an opportunity for the 

Service to address some of its long-standing challenges, including 

prefunding its retiree health obligations and accelerating its transformation 

to a more efficient and viable organization. While the Service’s proposals 

addressed the prefunding obligation, and the Service has indicated that it 

can support its transformation initiatives through normal rate increases, 

the extent to which it would be able to support or accelerate its 

transformation was not clear. Consequently, careful monitoring of the 

Service’s financial situation and the pace of its progress in implementing its 

transformation initiatives will be necessary.

One of the issues we considered in evaluating these proposals was the 

impact of the escrow requirement. The Service’s report proposes that the 

escrow requirement be eliminated, because the Service cannot use these 

funds unless Congress eliminates the escrow requirement or specifies by 

law how the escrow funds may be used. If no action were taken, the Service 

would not realize a reduction in its annual operating expense of over $3 

billion beginning in fiscal year 2006. Consequently, the Service believes it 

would have to raise rates higher than would otherwise be necessary. In our 

view, the escrow requirement could be one means to direct funding for 

specific purposes that Congress may believe to be especially important. 

Once Congress is satisfied, it could repeal the escrow requirement so that 

an escrow account is not needed, or it could indicate its preferences 

through means other than an escrow requirement.

Moreover, it is critical to the Service’s future viability that it continue to 

make progress on addressing its financial challenges, such as prefunding 

retiree health obligations, repaying debt, and financing capital needed to 

implement its transformation initiatives. We believe that Congress will 

need to have sufficient information to determine that the Service is making 

or accelerating progress in achieving its transformation goals. In this 

regard, we have already recommended that the Service provide periodic 

reports on the status of its transformation initiatives and other Commission 

recommendations, which the Service recently provided to its congressional 

oversight committees. In addition, the Chairman of the Senate Committee 

on Governmental Affairs and Senator Carper sent a letter to the Postmaster 

General dated November 19, 2003, asking for a comprehensive plan by 
Page 6 GAO-04-238 Postal Pension Funding Reform

early April 2004 that lays out how the Postal Service intends to optimize its 

infrastructure and workforce.

We also assessed Proposals I and II according to their fairness, 

affordability, and how they address the Service’s transformation efforts, 

including its cost saving and productivity improvement initiatives, as 

follows:

• Fairness: Proposal I strikes a more equitable balance of allocating costs 

between current and future ratepayers because benefits being earned by 

today’s employees would be built into the current postal rate base. 

Under Proposal II, a substantial portion of the retiree health benefits 

obligation would remain unfunded, thereby placing the burden of the 

retiree health benefits being earned today on future ratepayers. Fairness 

between ratepayers and taxpayers is also an issue, because P.L. 108-18 

transferred $27 billion in pension costs related to military service from 

the Treasury Department to the Postal Service—or in effect, from 

taxpayers to ratepayers—but required further study of who should be 

responsible for these costs. This issue is discussed in more detail in 

GAO’s related report.

• Affordability: The Service’s proposals attempt to balance both shortterm rate mitigation and some level of prefunding to address its longterm obligations. Given the Service’s uncertain financial future, the 

affordability of these proposals is tied to the Service’s ability to raise 

revenue, cut costs, and improve productivity and efficiency. In recent 

years, the Service has made some progress in cutting its costs and 

improving productivity but has had trouble raising sufficient revenue to 

offset declines in First-Class Mail volume. Under both proposals, the 

Service assumes that it can pay down debt and fund capital investment 

needs through periodic rate increases within normal inflationary trends. 

The Service’s proposals for prefunding some level of its retiree health 

benefits obligation would require modest additional rate increases over 

the amount needed to cover inflationary cost increases. The Service 

estimated that Proposal I would require an additional rate increase in 

fiscal year 2006 of 2 percent over the rate of inflation, while Proposal II 

would require only an additional increase of 0.3 percent over the rate of 

inflation since it is funding a smaller portion of the retiree health 

benefits obligation. The Service did not estimate the impact of either 

proposal on postal rates beyond fiscal year 2006. Furthermore, the 

Service did not propose to fully fund its retiree health benefits 

obligation in a specified time period under either proposal. However, 
Page 7 GAO-04-238 Postal Pension Funding Reform

even moderate rate increases to prefund some portion of the retiree 

health benefits obligation now could help the Service avoid more 

dramatic postal rate increases later.

• Transformation: In passing P.L. 108-18, several Members of Congress 

expressed the need for the Service to continue its modernization efforts 

to transform itself into a more efficient and effective organization. 

Further, the Commission and GAO have reported on the need for the 

Service to enhance its efficiency through such efforts as standardization 

of its mail processing operations, improving retail access, and 

rationalizing its infrastructure and workforce. The Service has begun 

implementing a number of its transformation initiatives to improve its 

efficiency and has made meaningful progress in a number of areas, 

including reducing its workforce, cutting costs, and improving 

productivity. To achieve additional results, sufficient capital investment 

will need to be made. Both proposals assume that the Service can raise 

sufficient capital through inflation-based rate increases. Although the 

Service has provided some information to us showing what capital 

investments it plans to make related to its transformation goals, it has 

not yet prepared a comprehensive, integrated plan showing how it plans 

to rationalize its infrastructure and workforce and the funding that 

would be needed to implement such a plan, as well as the savings or 

additional revenue the plan would be expected to generate. Without 

such a plan, and periodic updates on the status of transformation 

initiatives as we have previously recommended, as well as their cost and 

funding, it is not clear whether the Service’s planned funding would be 

sufficient.5 

Under both proposals, we also identified technical issues related to 

implementation of prefunding retiree health benefits obligation, including 

whether the Service should explore the implications of fully funding its 

retiree health benefits obligation over a specific time period; the proper 

demographic and economic assumptions to employ in estimating the 

obligation; and what agency should be responsible for making these 

decisions. 

To ensure continuing progress in addressing the Service’s financial 

challenges, we suggest that Congress consider the following:

5

U.S. General Accounting Office, U.S. Postal Service: Bold Action Needed to Continue 

Progress on Postal Transformation, GAO-04-108T (Washington, D.C.: Nov. 5, 2003).
Page 8 GAO-04-238 Postal Pension Funding Reform

• Repealing the escrow requirement after receiving an acceptable plan 

from the Service describing how it intends to rationalize its 

infrastructure and workforce and is confident that the Service is making 

satisfactory progress on transforming itself into a more efficient 

organization and implementing its transformation goals.

• Directing the Service to fund specific purposes that Congress believes 

are especially important—such as prefunding the retiree health benefits 

obligation or supporting and possibly accelerating the Service’s 

transformation efforts—if the Service does not provide an acceptable 

plan for rationalizing its infrastructure and workforce, or show 

satisfactory progress in implementing transformation, or if Congress 

wants greater assurance that the Service will spend funds in a particular 

manner. In this regard, we have already recommended that the Service 

provide periodic reports on the status of its transformation initiatives 

and other Commission recommendations.

• Addressing implementation issues related to prefunding the retiree 

health benefits obligation. For example, one key issue that would need 

to be further explored is what options may be available that would allow 

the Service to amortize its unfunded retiree health benefits obligation 

over a specified time period (e.g., 20-40 years) and prefund the retiree 

health benefits obligation for future retirees.

In commenting on a draft of our report, the Service disagreed with our 

Matters for Congressional Consideration that repeal of the escrow 

requirement should be tied to an acceptable plan. We agree that 

establishing an escrow account without allowing the Service to use the 

funds would not be a desirable outcome and that is one of the reasons why 

we suggested that Congress consider repealing the escrow requirement. On 

the other hand, contrary to the Service's view, we believe the escrow 

requirement is an opportunity for Congress to review how the Service plans 

to address a number of long-term challenges, including debt repayment, 

capital projects, its unfunded retiree health benefits obligation, and its 

progress toward transformation. If the Service provides Congress with an 

acceptable plan in the next several months and Congress finds the plan and 

the Service’s transformation progress satisfactory, we believe Congress 

should have sufficient time to repeal the escrow requirement so that an 

escrow account would not be needed. Thus, the Service would not have to 

include the operating expense associated with the escrow requirement in 

its rate base for the next rate case filing.
Page 9 GAO-04-238 Postal Pension Funding Reform

Background In April 2003, Congress enacted P.L. 108-18, which reduced the Service’s 

annual payment into the CSRS pension fund, in part, to reflect a reduction 

in the Service’s estimated unfunded obligation for prior years’ service from 

about $30 billion to about $5 billion. The difference between the Service’s 

CSRS payment required prior to enactment of P.L. 108-18 and the payment 

after enactment is labeled the “savings” in the legislation. However, P.L. 

108-18 requires the Service to use the savings in fiscal years 2003 and 2004 

to pay down outstanding debt and in fiscal year 2005 to extend the current 

rate cycle. Therefore, according to the Service, all of the overfunding 

generated by current rates will be completely consumed by the end of fiscal 

year 2005. In fiscal year 2006, the Service is required to begin making 

payments into an escrow account that it cannot use until otherwise 

provided for by law. The amount of the payments into the escrow account 

would have to be included in the Service’s rate base. The Service’s report 

recommended that the escrow requirement be repealed, and provided two 

proposals for use of the “savings.” A brief description of each proposal is 

given below.

Proposal I Transferring the military costs from the Service to the Treasury, as detailed 

in Proposal I, increases the projected overfunding of the postal CSRS 

pension fund from $78 billion to $105 billion. This would result in an overall 

cost reassignment of $27 billion and a $10 billion overfunding of the postal 

CSRS pension fund as of the end of fiscal year 2002. The Service proposes 

that the $10 billion in overfunding would remain in the pension fund, in a 

separate account designated as the “Postal Service Retiree Health Benefit 

Fund (Retiree Health Fund).” The Service made a payment of about $1.3 

billion for its pension obligation into the CSRS pension fund in fiscal year 

2003. Under current legislation, it would continue to make payments of 

$2.2 billion in fiscal year 2004 and $2.1 billion in fiscal year 2005. If 

responsibility for all military service costs is transferred back to the 

Treasury, the resulting overfunded status would negate the need for further 

Postal Service annual CSRS payments.6

 The Service proposes that the 

CSRS payments it made in fiscal year 2003, and will make in fiscal years 

2004 and 2005, remain in the CSRDF in the newly designated Retiree Health 

Fund. Beginning in fiscal year 2006, the Service proposes to make annual 

6

Postal employees would continue to make their contributions to the CSRS fund, which are 

currently 7 percent of pay. 
Page 10 GAO-04-238 Postal Pension Funding Reform

payments into the Retiree Health Fund. This new fund would be used to 

pay retiree health insurance premiums in the future. 

This proposal assumes that the escrow requirement would be eliminated. 

However, the Service estimates that the expense for prefunding retiree 

health obligations would add $1.2 billion to its expenses in fiscal year 2006. 

The Service estimates that this expense would require a rate increase that 

would be 2 percent higher than would be necessary to cover inflationary 

expense growth. Otherwise, the Service believes it can pay down debt and 

finance its capital investment needs through its normal cycle of inflationbased rate increases.

Proposal II Proposal II, other than funding a small amount of the retiree health benefits 

obligation, results primarily in rate mitigation. This proposal is based on 

the assumption that the escrow requirement would be repealed and that 

the Service would remain responsible for military service costs. Under this 

scenario, the Service proposes to prefund the retiree health benefits cost 

for employees hired after fiscal year 2002. It would not fund the retiree 

health benefits cost already incurred for current and former employees, 

which comprises most of the obligation. The Service estimates that the 

expense created to prefund retiree health benefit costs for new employees 

would require a rate increase in fiscal year 2006 that would be 0.3 percent 

higher than necessary to cover normal inflationary expense growth. 

Although the Service’s proposal stated that some funds would be used to 

pay down debt and fund capital investments, postal officials have told us 

that the proposed debt repayment and capital investment costs are equal to 

what they had planned to spend regardless of enactment of P.L. 108-18. 

Consequently, the Service believes that, absent the escrow requirement, it 

would be able to continue to pay the retiree health premium costs for 

current and former employees on a pay-as-you-go basis, pay down debt, 

and finance its capital investment needs through normal rate increases that 

would correspond with general inflation trends.

Both Proposals Are 

Generally Consistent 

with P.L. 108-18

We believe that both proposals are generally consistent with the “Sense of 

Congress” expressed in P.L. 108-18, that some portion of the savings should 

be used to address the Service’s unfunded obligations. However, Proposal I 

goes much further in this area because it proposes prefunding a substantial 

portion of retiree health benefits for all current and former employees, 

while Proposal II would prefund these costs only for employees hired after 
Page 11 GAO-04-238 Postal Pension Funding Reform

fiscal year 2002. Both proposals also address, to varying degrees, the 

Matters to Consider, outlined in P.L. 108-18. Proposal I addresses, almost 

exclusively, matter (ii)—prefunding of postretirement health benefits for 

current and former employees. Proposal II addresses matter (ii) to a 

limited extent, and matter (iv)—delaying or moderating increases in postal 

rates. Under both proposals, the Service believes that it can address matter 

(i)—debt repayment—and matter (iii)—productivity and cost saving 

capital investments—through inflation-based rate increases.

The legislation also directed the Postal Service to consider the work of the 

Commission. The Commission recommendations, like our previous work, 

stressed the significance of funding the retiree health benefits cost to the 

extent that the Service’s finances permit. The Commission pointed out that 

the pension obligation is funded as benefits are earned and recovered 

through rates, but the retiree health benefits obligation is funded as the 

benefits are paid and not as they are earned. The Commission strongly 

urged the Service to consider funding a reserve account to begin paying 

down the retiree health benefits obligation so future ratepayers are not 

forced to pay for costs associated with postal services delivered today. The 

Commission also stated that raising rates should be the last recourse, not 

the first, to cover rising costs. In our November 2003 testimony before the 

Senate Committee on Governmental Affairs, we also raised concerns about 

rate increases, stating that raising rates may provide an immediate boost to 

the Service’s revenues but would likely accelerate the transition of mailed 

communications to electronic alternatives.7 In addition, the Commission 

expressed concern regarding the Service’s ability to repay its debt and 

stressed the importance of the Service improving its operational efficiency. 

Another important recommendation of the Commission was that the 

Service should review its current policy relating to the accounting 

treatment of retiree health care benefits, and work with its independent 

auditor to determine the most appropriate treatment of such costs in 

accordance with applicable accounting standards and in consideration of 

the Postal Service’s need for complete transparency in the reporting of 

future liabilities. We have also discussed these issues in our previous 

work.8

 Proposal I addresses the issue of funding retiree health benefits to a 

7

GAO-04-108T.

8

U.S. General Accounting Office, Major Management Challenges and Program Risks: U.S. 

Postal Service, GAO-03-118 (Washington, D.C.: January 2003); and U.S. Postal Service: 

Deteriorating Financial Outlook Increases Need for Transformation, GAO-02-355

(Washington, D.C.: Feb. 28, 2002).
Page 12 GAO-04-238 Postal Pension Funding Reform

greater extent than Proposal II, while Proposal II addresses the matter of 

mitigating rates to a greater extent than Proposal I.9

 Both proposals 

address the issue of debt repayment and capital investment through 

inflation-based rate increases. 

Escrow Requirement 

Places Pressure on 

Rates

The Service recommended in its report that Congress eliminate the escrow 

requirement, because of its negative impact on postage rates and the 

mailing industry, the general public, and the economy as a whole. The 

Service estimates that it would need an additional rate increase of 5.4 

percent, including 2 cents on the 37-cent First-Class stamp, in order to 

generate the $3.2 billion required to be placed in an escrow account in 

fiscal year 2006. This is because P.L. 108-18 requires all “savings” 

attributable to fiscal years after 2005 to be considered an “operating 

expense” and placed into an account that the Service cannot use until 

Congress specifies how the funds may be used. All of the “savings” 

accruing under current rates would likely be expended or absorbed by 

inflationary cost increases by the end of fiscal year 2005. Thus, in order to 

pay this “operating expense” the Service would need to include the $3.2 

billion in its rate base in fiscal year 2006 and collect the money from its 

ratepayers or lower expenses by a corresponding amount. The Service has 

taken steps to reduce its total expenses over the past 2 fiscal years, and we 

believe it is important for the Service to continue its cost-cutting efforts. 

However, setting aside unused funds in an escrow account that must be 

considered an “operating expense” would serve to lessen the financial 

benefits of the Service’s cost-cutting efforts.

For fiscal years after 2006, an increasing amount—estimated to eventually 

reach a peak of $8.7 billion—would have to be placed annually in the 

escrow account. This would be in addition to its operating expenses, such 

as compensation and retiree health premiums, as well as any amounts 

needed to pay down debt or fund capital investments. The Service 

estimates that it would require additional biannual rate increases between 

1 percent and 1.5 percent to cover the required escrow amount. Frequent 

rate increases of this magnitude would likely hasten the decline in First9

It should be noted that Proposal I, by funding retiree health benefits for current and former 

employees only if it is relieved of responsibility for military service costs, also addresses 

rate mitigation because funding this obligation for current and former employees, while 

retaining responsibility for military service costs, would result in even higher rate increases.
Page 13 GAO-04-238 Postal Pension Funding Reform

Class Mail volume and increase the risk of volume declines in other mail 

classes. 

In our view, the escrow requirement could be viewed as one means to 

direct funding for specific purposes that Congress may believe to be 

especially important. We also believe it is critical to the Service’s future 

viability that it continue to make progress on addressing its financial 

challenges, such as prefunding retiree health obligations, repaying debt, 

and financing capital needed to implement its transformation initiatives. 

Several options include (1) tying the repeal of the escrow requirement to 

congressional review of the Service’s progress on transformation, which 

could include the Service providing Congress with an acceptable plan for 

realigning its infrastructure and workforce; (2) repealing the escrow 

requirement but specifying the use of funds; or (3) repealing the escrow 

requirement and allowing the Service to fund activities as specified in its 

proposals. Another option would be to retain the escrow requirement and 

direct funding for specific purposes, which would likely require Congress 

to periodically revisit the use of funds. We believe this option could be 

problematic if an impasse arose, which could make the funds unavailable 

to the Service to spend on specific purposes. 

If Congress does not want to specify by law the purposes and amounts that 

should be funded, but rather permit the Service to decide which activities 

to fund, we believe that Congress would need to have sufficient 

information to determine that the Service is making or accelerating 

progress in achieving its transformation goals. In this regard, we have 

already recommended that the Service provide periodic reports on the 

status of its transformation initiatives and other Commission 

recommendations that fall within the scope of its existing authority. The 

Chairman of the Senate Committee on Governmental Affairs, along with 

Senator Carper, requested in a letter to the Postmaster General dated 

November 19, 2003, that the Service provide the Committee with a 

comprehensive plan that lays out how the Service intends to optimize its 

infrastructure and workforce. Further, the letter requested biannual 

updates on the status of implementing transformation initiatives and 

recommendations of the Presidential Commission. In November 2003, the 

Service provided the congressional oversight committees with a progress 

report on its transformation initiatives.
Page 14 GAO-04-238 Postal Pension Funding Reform

Key Issues Used to 

Assess the Postal 

Service’s Proposals

We also assessed the Service’s two proposals in the context of three key 

issues emerging from our previous work and the Commission’s 

recommendations. The first issue is whether the proposals are fair and 

balanced between current and future ratepayers regarding who pays for 

employee benefits earned today. Another aspect of this issue is fairness 

between ratepayers and taxpayers regarding responsibility for military 

service costs and the effect of the proposals on the federal budget. The 

second issue is whether the proposals are affordable in light of the 

Service’s current financial situation. Given declining First-Class Mail 

volume, rising compensation costs, and a significant retiree health benefits 

obligation, if the Service’s proposals greatly exacerbate these financial 

challenges, affordable universal service could be jeopardized. The third 

issue is how these proposals assist the Service in achieving or accelerating 

its transformation initiatives. The importance of this issue lies in the need 

for the Service to become a more efficient and effective organization in 

order to remain financially viable.

Fairness Issues One factor that should be kept in mind when evaluating these proposals is 

the issue of maintaining an equitable balance between the postal costs paid 

for by current and future ratepayers and the impact of these proposals on 

taxpayers. As we noted in our November 2003 testimony, under the 

Service’s current accounting and rate-setting methods, current ratepayers 

have not fully covered the total costs of the postal services they have 

received.10 Further, future ratepayers are likely to face more significant and 

frequent rate increases to cover the cost of benefits being earned by 

current employees. The equity of this arrangement should be considered in 

evaluating these proposals. Likewise, the effects of these proposals on the 

federal budget—which specifies the spending and financing of the federal 

government—and whether these effects are equitable to both ratepayers 

and taxpayers, should also be considered.

Proposal I strikes a better balance between current and future ratepayers 

by prefunding the retiree health benefits obligation for both retirees and 

current employees and providing a mechanism for better aligning current 

expenses with current revenues. Therefore, benefits being earned by 

today’s employees would be built into the current rate base. 

10GAO-04-108T.
Page 15 GAO-04-238 Postal Pension Funding Reform

While Proposal II does partially address the issue of striking a balance 

between current and future ratepayers in regard to the retiree health 

benefits obligation, it does not go as far as Proposal I in this area. By only 

prefunding the retiree health benefits cost for new employees, it leaves a 

sizable portion of this obligation unfunded. This means that future 

ratepayers will still be required to pay for most of the retiree health benefits 

earned by today’s workforce. In addition, mailers argue that prior to 

enactment of P.L. 108-18, they were paying too much for the CSRS 

obligation; therefore, mitigating rate increases now is merely recompense. 

However, while mailers may have been paying more than necessary to fund 

the pension obligation, they were paying less than necessary to fund the 

retiree health benefits obligation.

Fairness between 

Ratepayers and Taxpayers 

Another important consideration is the effect these proposals would have 

on the federal budget and, therefore, the taxpayer. An issue currently 

before Congress is who should be responsible for paying the military 

service pension costs of postal employees covered by CSRS. Proposal II is 

predicated on the assumption that current ratepayers pay for pension costs 

related to military service, much of which was vested prior to creation of 

the Postal Service and had already been paid by Treasury. If Congress 

decides that the Service should retain responsibility for these costs, the 

postal ratepayers would bear the costs. If Congress determines that the 

Treasury should be responsible for these costs, then the costs would be 

borne by taxpayers. The Service has stated that the impact on the federal 

budget of transferring these costs under Proposal I would likely be 

minimal. The budgetary effects of the Service’s proposals have not been 

scored by CBO. However, based on its scoring of the Postal Civil Service 

Retirement System Funding Reform Act, we believe that Proposal I might 

be scored as having little effect on the deficit in the short term. In the long 

term, it could have an effect when the Service’s cash flow changes in later 

years as the prefunded benefits are paid. However, insufficient detail has 

been provided on both proposals to determine their overall budget effects.

The CBO is required to “score,” or estimate, the budgetary effects of 

legislation reported out of committees, so it has not scored the Service’s 

proposals. However, the CBO scoring report on the bill that resulted in the 

pension legislation provides some insight into how this proposal might be 

scored.

CBO scoring considers both on-budget and off-budget effects of legislative 

proposals. As an off-budget entity, any payments that the Service makes to 
Page 16 GAO-04-238 Postal Pension Funding Reform

the retirement trust fund (an on-budget entity) are considered offsetting 

receipts; reducing those payments would reduce on-budget receipts. Under 

P.L. 108-18, after fiscal year 2005, savings resulting from the act are to be 

considered operating expenses of the Service. Therefore, these expenses 

would be included in rate setting, even though the Service’s actual 

expenses would decline by the amount placed in escrow. As a result, net 

off-budget outlays of the Postal Service would decline by the same amount 

as the savings from lower pension payments, beginning in fiscal year 2006. 

This is reflected in the CBO scoring report. These lower off-budget outlays 

would offset the on-budget impact of lower payments to CSRS. Thus, any 

proposal that uses the escrowed savings could affect the overall federal 

budget deficit.

Scoring of the Service’s proposals hinges on what the Service would do 

with the escrowed savings. Proposal I, in shifting the cost of military 

service back to the Treasury, would result in a reduction in on-budget 

receipts. But Proposal I, in using most of the savings to prefund retiree 

health benefits, would also keep those amounts in a separate CSRS 

account. 11 The combined impact might be scored as having little effect on 

the deficit in the short term. However, in the long term, it could have an 

effect because at some point, the prefunded benefits would be paid out, 

resulting in changes in cash flows in later years. In addition, Proposal I 

would use a small amount of the savings for debt reduction, which would 

cause on-budget interest receipts to be lower. 

Under Proposal II, which assumes that the Service would retain 

responsibility for the military service costs, the Service said it would fund 

its retiree health benefits obligation only for its employees hired after fiscal 

year 2002 and then fund, in priority sequence, debt repayment and capital 

investments to improve productivity and cost-savings. This proposal also 

raises issues related to the federal budget. The continuation of payments 

for military service costs would mean that there would be no reduction in 

on-budget receipts. In the short term, prefunding some retiree health 

benefits could have a small positive effect on the budget, because the 

Service would be collecting revenue that would not be immediately paid 

out. In general, any reduction in the Service’s debt would reduce on-budget 

interest receipts. Any additional capital investments would increase offbudget outlays. However, if the Service can provide credible support that 

11Proposal I specifies that any overfunding not be withdrawn from the separate account. If 

it were withdrawn, there would also be on-budget outlays.
Page 17 GAO-04-238 Postal Pension Funding Reform

the investments would result in cost savings, the scoring may show 

increased outlays initially and savings subsequently. 

Affordability of Proposals Is 

Unclear

The Service believes that its proposals are affordable, meaning they would 

not cause rate increases that irreparably harm volume, or hinder the 

Service’s ability to sustain current operations and implement 

transformation initiatives. We are concerned that the Service may not be 

able to achieve all of these goals if its financial situation worsens. 

Therefore, we believe it is imperative for the Service to continue 

addressing its key financial challenges—long-term obligations and debt, 

difficulty raising revenue, and aggressive cost-cutting measures—to the 

extent that it is able. The Service faces a difficult challenge in trying to 

balance all of these issues. The Service’s proposals attempt to balance both 

short-term rate mitigation and some level of prefunding of retiree health 

obligations to address its long-term obligations, while also providing for 

debt repayment and capital investment. However, the Service did not 

present an analysis of how its proposals would affect the overall financial 

condition of the Postal Service. Consequently, it is difficult to assess which, 

if either, of these proposals would improve the long-term financial situation 

of the Postal Service or ensure its future financial viability. Therefore, we 

believe that the Service’s financial situation will need to be closely 

monitored to ensure that its proposals are indeed affordable. 

The affordability of these proposals to ratepayers is also a consideration, as 

is the effect of rate increases on volume because, as we have previously 

reported, the Service faces uncertainty regarding its future revenue 

stream.12 Since fiscal year 2000, the Service’s total mail volume has declined 

by almost 6 billion pieces and is estimated to continue declining. In a report 

for the Commission, the Institute for the Future developed a mail volume 

estimate that shows a gradual 10 percent decline from 202.8 billion pieces 

in fiscal year 2002 to 181.7 billion pieces in 2017. Also, First-Class Mail 

volume, which provides the bulk of the Service’s revenue, has been 

declining and shows no sign of rebounding. Declines in First-Class Mail are 

particularly troublesome to the Service, because First-Class Mail pays 

almost 70 percent of the Service’s institutional costs. These costs, which 

are approximately 40 percent of all postal expenses, include some 

administrative, facility, postmaster, and supervisor costs, and a large 

12GAO-04-108T.
Page 18 GAO-04-238 Postal Pension Funding Reform

portion of the expanding delivery network costs. Therefore, if First-Class 

Mail volume continues to decline, it would become more difficult for the 

Service to fund its institutional costs without raising postal rates.

Historically, when the Service has raised postal rates, mail volume growth 

declined in the fiscal year immediately following the rate increase but 

rebounded in the next fiscal year. However, over the last 3 years this has 

not been the case. The Service raised rates twice in fiscal year 2001 and 

once in fiscal year 2002. Total estimated mail volume at the end of fiscal 

year 2003 was almost 6 billion pieces lower than total mail volume was in 

fiscal year 2000. In this climate, rate increases may lead to further volume 

declines, which in turn would necessitate additional rate increases and 

begin a cycle often referred to as the “death spiral.” 

The Service’s first proposal would require a larger rate increase than the 

second proposal. Under Proposal I, the Service estimates that prefunding 

retiree health benefits would add $1.2 billion to its expenses in fiscal year 

2006 compared with its expenses in that year under the current law, 

assuming the escrow requirement were eliminated. According to the 

Service, this additional expense would require a rate increase in fiscal year 

2006 that is 2 percent higher than the increase that would be necessary due 

to inflationary expense growth alone. In fiscal years after 2006, the Service 

would continue to make these additional payments and future rate 

increases would likely be marginally higher than would be necessary to 

reflect inflationary pressures alone.13 Figure 1 shows the annual additional 

amount the Service proposes to spend on prefunding under Proposal I. 

13It is important to note, however, that rate increases would not be higher than they would 

have been if P.L. 108-18 had not lowered the Service’s annual CSRS pension payments.
Page 19 GAO-04-238 Postal Pension Funding Reform

Figure 1: Additional Expense Generated from Proposal I

If the Service’s mail volume continues to decline and the Service is unable 

to cut costs accordingly, or if the Service is faced with higher retiree health 

premium costs than estimated, the Service may not be able to afford to 

continue prefunding the retiree health benefits obligation. Therefore, the 

Service’s financial condition must be carefully monitored under this 

proposal.

Proposal II would require a lower rate increase than Proposal I in fiscal 

year 2006, and thus would likely have less of an impact on postal volumes 

in the short term. However, in the long-term it may require larger rate 

increases that could have a negative impact on future volumes. As seen in 

figure 2, the estimated retiree health premium expense will eventually 

outpace the estimated difference between the CSRS payment prior to 

enactment of P.L. 108-18 and the payment required under the legislation. 

Consequently, in order to pay the retiree health premiums in the future, the 
Page 20 GAO-04-238 Postal Pension Funding Reform

Service would need to raise additional revenue through rate increases or 

lower its operating expenses. 

Figure 2: Comparison of Retiree Health Premiums and “Savings” under Proposal II

The Postal Service is required to pay the retiree health premiums 

regardless of whether it prefunds some or all of these costs, and the annual 

costs are expected to increase over the next 20 years. If prefunding retiree 
Page 21 GAO-04-238 Postal Pension Funding Reform

health benefits for new employees proves to be more costly than estimated, 

or if the premiums for current retirees continue to grow rapidly, the Service 

could find itself facing a significant obligation at a time when revenues are 

shrinking. It seems prudent to set aside funds now, while they are available, 

to address escalating future costs rather than waiting until costs are higher 

and adequate revenue may not be forthcoming. Because Proposal II would 

result in a smaller rate increase in fiscal year 2006 than Proposal I, it raises 

the question of whether it would be possible for the Service to increase its 

proposed level of prefunding retiree health benefits under Proposal II. By 

setting aside an additional $1 billion in funding for this obligation, the 

Service would need an additional rate increase of 2 percent, the same 

increase the Service proposes under Proposal I. The Service has stated that 

the decision to prefund only retiree health benefits for new employees 

arose from the desire to have a logical basis for its funding proposal. 

Because the legislation was enacted in fiscal year 2003, the Service decided 

to begin prefunding with a corresponding time period. While this may 

provide a baseline, we agree with the Commission that the Service should 

address its retiree health benefits obligation to the extent that its financial 

situation allows. Again, we believe the Service’s financial situation will 

have to be carefully monitored to ensure that this option remains 

affordable.

Another factor associated with the affordability of the proposals concerns 

how they address the Service’s outstanding debt level, which in fiscal year 

2002 was close to statutory limits and was threatening the Service’s ability 

to fund capital improvements. The Service made significant progress in 

reducing its outstanding debt in fiscal year 2003, from $11.1 billion to an 

estimated $7.3 billion, and plans to continue paying down its debt in fiscal 

years 2004 and 2005. The Service has estimated that debt outstanding as of 

the end of fiscal year 2005 will be $3 billion. Under both proposals, the 

Service proposes to repay the same amount of debt in fiscal years 2006-

2010. As seen in table 1, the Service estimates that its outstanding debt will 

be paid off by 2010. These estimates assume that the Service would raise 

rates when necessary to break even for each of the fiscal years 2006 

through 2010. If this break-even assumption is not correct, or if the Service 

faces unforeseen financial problems, the Service may not be able to pay 

down the amount of debt it proposes, and may, in fact, have to borrow 

more.
Page 22 GAO-04-238 Postal Pension Funding Reform

Table 1: Estimated Debt Repayment and Capital Investment under Proposal II

Source: U.S. Postal Service.

The affordability of these proposals is also tied to a separate matter 

currently before Congress—who should bear responsibility for military 

service pension costs and how these costs should be determined. If 

Congress determines that the Treasury should bear responsibility for 

military service costs, then the Service believes that it can afford to prefund 

retiree health care costs for all of its current and former employees. If 

Congress determines that the Service should retain responsibility for the 

military service costs, then the Service believes that it can only afford to 

prefund the retiree health benefits cost for employees hired after fiscal year 

2002, which would leave the obligation for current and former employees 

unfunded. 

As both the Commission and we have noted, the Service has had limited 

success in its pursuit of new revenue streams. Therefore, to counter the 

loss in revenue due to declining mail volume without resorting to frequent 

rate increases, the Service must aggressively cut costs. To its credit, the 

Service has decreased work hours, reduced its workforce, and closed some 

facilities. However, we do not believe that these incremental savings will 

be enough to ensure a financially viable Postal Service over the longer 

term, especially if mail volumes continue to decline. For this reason, we 

believe the Service must continue to make progress in implementing its 

transformation goals. 

Dollars in millions

Fiscal year

Beginning debt 

balance

Estimated debt 

payment Ending debt balance

2006 $3,000 $776 $2,224

2007 2,224 540 1,684

2008 1,684 612 1,073

2009 1,073 521 552

2010 552 559 (7)
Page 23 GAO-04-238 Postal Pension Funding Reform

Transformation Issues In assessing these proposals, we also considered how the Service would be 

able to fund cost saving and productivity initiatives needed to successfully 

transform itself into a viable organization for the 21st century. In April 2002, 

in response to a GAO recommendation14 and a request by the Senate 

Committee on Governmental Affairs, the Postal Service prepared a 

Transformation Plan that outlined strategies for transforming the 

organization into an efficient and performance-based entity. Among those 

initiatives were plans to standardize operations, increase customer access, 

and realign the processing and distribution network. The Commission’s 

report also made suggestions for improving postal efficiency. We agree with 

the Commission that the Service must continue to pursue aggressive costcutting strategies and productivity gains in an effort to become more 

efficient. We also believe that the mandate for the Service to report on the 

potential use of savings from P.L. 108-18 was an opportunity for the Service 

to present its plans in this area, and the Service’s proposals must be 

evaluated with the need for cost-cutting and productivity gains in mind. 

Under both proposals, the Service believes it can finance capital 

investments related to upgrading existing assets and the investment needed 

to implement transformation initiatives through inflation-based rate 

increases. We are concerned that the Service’s financing plan may not be 

adequate to provide for its capital investment needs, because historically, 

the Service has found it problematic to finance its capital needs with 

operating revenues. Thus, it has often resorted to borrowing to finance its 

capital needs. In contrast, under both proposals, the Service would finance 

its capital needs while continuing to pay down debt through inflation-based 

rate increases. Another possible source of capital funds could be the 

proceeds from the sale of excess property. However, the Service did not 

discuss this issue in its report.

We are also concerned with the Service’s lack of specifics on capital 

investments under both proposals. While the Service stated that its capital 

investments for productivity gains and cost saving initiatives were related 

to its Transformation Plan, it has provided little detail on any of these 

initiatives in its pension savings report, its Five-Year Strategic Plan FY 2004-

2008, or its Five-Year Strategic Capital Investment Plan 2004-2008. The 

Service did provide a breakdown of some capital investments related to its 

Transformation Plan initiatives, but did not provide sufficient back-up data 

14GAO-01-598T.
Page 24 GAO-04-238 Postal Pension Funding Reform

or description to enable us to determine to what transformation initiatives 

these investments were related or to what extent they would meet 

transformation goals.

In our November 2003 testimony, we also noted our concern that since the 

Service issued its Transformation Plan in April 2002, it has not provided 

adequate transparency on its plans to rationalize its infrastructure and 

workforce; the status of initiatives included in its Transformation Plan; and 

how it plans to integrate the strategies, timing, and funding necessary to 

implement its plans.15 While the Postal Service is moving forward with its 

Transformation Plan initiatives, and has made meaningful progress in a 

number of areas, it is not clear how it will be able to finance these 

initiatives within inflation-based rate increases, especially if mail volume 

continues to decline. Therefore, we recommended in our November 

testimony that the Postmaster General develop a comprehensive and 

integrated plan to optimize the Service’s infrastructure and workforce, in 

collaboration with its key stakeholders, and make it available to Congress 

and the general public. We also recommended that the Postmaster General 

provide periodic reports to Congress and the public on the status of 

implementing its transformation initiatives and other Commission 

recommendations that fall within the scope of its existing authority. Postal 

officials have agreed to develop a comprehensive and integrated plan to 

optimize its infrastructure and provide periodic reports on the 

implementation of its transformation initiatives and make them available to 

Congress and the public. As previously mentioned, the Service provided its 

congressional oversight committees with a progress report on its 

transformation initiatives in November 2003. The infrastructure and 

workforce plan and the periodic reports on the status of transformation 

initiatives will be critical to oversight in this area.

Issues Related to the 

Implementation of 

Proposals I and II

During our review, we identified implementation issues that Congress may 

want to consider if it determines that the Service should prefund some or 

all of its retiree health benefits obligation. Under Proposal I, 

implementation issues involve the method that would be used to fund the 

retiree health benefits, and the demographic and economic assumptions 

that would be used to determine the amount of the total obligation as well 

as the annual funding amount. Under Proposal II, the question arises as to 

15GAO-04-108T.
Page 25 GAO-04-238 Postal Pension Funding Reform

how the annual cost of retiree health benefits for employees hired after 

fiscal year 2002 would be calculated. In addition, neither proposal ensures 

that the Service would continue to prefund the retiree health benefits 

obligation. Additional questions arise about the Service’s accounting 

treatment for retiree health benefits under both proposals. 

If Congress decides to accept one of the proposals, technical issues related 

to implementing the proposal would need to be addressed. Under Proposal 

I, the Service would fund the retiree health benefits obligation by making 

payments into a fund currently maintained by OPM. Postal officials raised 

questions about which agency—the Service or OPM—should determine the 

amount of the obligation, and what economic and demographic 

assumptions should be used. In addition, we have questions about the 

Service’s proposed funding mechanism, because it does not amortize the 

obligation over a specific time period. In Proposal II, the Service would 

maintain control of the retiree health benefits fund. Under both proposals, 

the Service would continue to make payments into the respective funds 

after 2010; however, under P.L. 108-18, the Service would be under no 

obligation to prefund the retiree health benefits obligation. 

Technical Issues Related to 

Proposal I

One issue pertains to the assumptions used by the Service to estimate its 

retiree health benefits obligation. If these assumptions change, then the 

future funded status of the obligation would also change. This estimated 

obligation is based on several assumptions, such as premium costs, 

retirement rates, termination rates, mortality assumptions, disability 

assumptions, plan enrollment, and coverage election that could change 

annually and may differ between the Postal Service and other agencies. 

These assumptions materially affect the future funded status of the 

obligation. An illustration of the practical effect of using different 

assumptions can be seen in the estimate of the Service’s total retiree health 

benefits obligation. A postal estimate of its retiree health benefits 

obligation as of the end of fiscal year 2003 differs from an estimate for the 

same period prepared by OPM by about 4 percent, or $2.2 billion. 

According to the Service, the difference in these two estimates is primarily 

due to differences in the measurement date, the discount rate, the health 

care trend rate, the cost basis, and the attribution method used. The 

Service’s estimate was actuarially certified as reasonable. However, a 

different set of results could also be considered reasonable actuarial 

results, because the actuarial standards describe a “best-estimate range” 

for each assumption rather than a single best-estimate value. 
Page 26 GAO-04-238 Postal Pension Funding Reform

In addition, the Service said it would not amortize the retiree health 

benefits obligation within a specified time frame. Instead, the proposed 

funding that the Service calculates to address its retiree health benefits 

obligation is the amount that would be required to fund the annual retiree 

premium cost plus the estimated future cost of retiree health premiums for 

current employees (service costs), and interest expense on both the 

outstanding obligation and the new service cost. According to the Postal 

Service, while it is the Service’s intention to eventually fully fund its retiree 

health benefits obligation under Proposal I, this proposal does not fully 

fund all prior years’ service costs—the $54 billion obligation—within a 

specified time period. In fact, because the proposed funding under 

Proposal I includes a beginning asset balance of $10 billion, but does not 

amortize any of the retiree health benefits obligation, approximately $45 

billion of the obligation would not be funded. The Service’s proposed 

funding for the retiree health benefits obligation is modeled after the 

funding method used by some utilities to prefund their retiree health 

benefits. However, other options might allow the Service to amortize its 

existing obligation and prefund the retiree health benefits obligation for 

future retirees. While postal officials indicated that under these proposals 

the Service intends to make annual payments for prefunding, the Service 

would be under no obligation to do so. Consequently, if Congress wanted to 

ensure that the Service prefunds its retiree health benefits, legislative 

action would be required. 

In considering Proposal I, we identified the following unresolved questions:

• Should prefunding Postal Service retiree health benefits be mandated by 

Congress, or left to the Service’s discretion? 

• Should the Postal Service, OPM, or another entity determine the amount 

of the Service’s total retiree health benefits obligation?

• Who should determine the proper funding mechanism for the retiree 

health benefits obligation? 

• Should the Postal Service be required to amortize its prior years’ service 

obligation within a set time frame? If so, what is the appropriate time 

frame?

• What economic and demographic assumptions should be used to 

determine the current obligation, service costs, and asset balance, and 

future estimates of these amounts? Furthermore, how often should 
Page 27 GAO-04-238 Postal Pension Funding Reform

these assumptions be updated, and what process should be used to 

update future estimates?

• What recourse, if any, should parties have if they disagree with this 

funding mechanism?

• What oversight, if any, is needed in this area?

Technical Issues Related to 

Proposal II

According to postal officials, unlike Proposal I, in Proposal II the Service 

would maintain control of the funds used to prefund the retiree health 

benefits cost for new employees. These officials have also stated that the 

Service would be responsible for determining the proper economic and 

demographic assumptions to be used in calculating the annual fund 

amount. However, questions arise about how the Service estimated these 

costs for fiscal years 2006-2010. For example, the Service provided us with 

estimates of these costs that ranged from $214 million in fiscal year 2006 to 

$687 million in fiscal year 2010. The Service then adjusted these numbers 

downward to $100 million for fiscal year 2006 and to $300 million for fiscal 

year 2010. According to postal officials, this downward adjustment was 

made to reflect attrition. Although we attempted to verify the method used 

to lower these estimated costs, we were unable to obtain the necessary 

data in the time available to complete our work. As with Proposal I, while 

the Service has said that it intends to fund this obligation for employees 

hired after fiscal year 2002, it is not currently required to prefund. 

Questions similar to those raised in Proposal I would also relate to 

consideration of this proposal, including the following:

• Should prefunding retiree health benefits for new employees be 

voluntary or legislatively mandated?

• How should the annual funding amount be determined?

• What oversight, if any, is needed in this area?

Questions Remain about the 

Accounting Treatment of 

the Retiree Health Benefits 

Obligation

Regardless of which proposal is adopted, questions remain about how the 

retiree health benefits obligation should be reflected in the Service’s 

financial statements. The Service currently uses a pay-as-you go basis of 

accounting for its retiree health benefits obligation. We previously reported 

that we believe the Service should consider whether the accrual basis of 

accounting is both the acceptable and appropriate method for this 
Page 28 GAO-04-238 Postal Pension Funding Reform

obligation, especially considering the importance of giving full 

consideration to economic realities as the Service attempts to transform 

itself in order to respond to major operational and financial challenges.16

Postal Service management and the Board of Governors, the Postal Rate 

Commission, Congress, and other stakeholders need to have a clear 

understanding of the Service’s true financial condition as difficult 

transformation decisions are being considered. 

It is our understanding that the Service would not adopt the accrual basis 

of accounting under either of the proposals presented, but would disclose 

the amount of its retiree health benefits obligation in the footnotes to its 

financial statements. While enhanced disclosure would be a positive step, 

we continue to believe that accrual accounting is needed in order to 

provide all stakeholders with the soundest and most transparent basis for 

decisionmaking. In our view, the enactment of P.L. 108-18 could be viewed 

as a significant event that triggers the need to reassess the accounting 

treatment currently used by the Service with respect to these obligations, 

and even more strongly reinforces our view that full accrual accounting 

should be adopted for financial statement reporting purposes. Given the 

unique nature of the Postal Service retiree health benefits obligation and 

the impact of P.L. 108-18, it may be prudent for the Service and its auditors 

to consult with the Financial Accounting Standards Board (FASB) on the 

appropriate accounting treatment for this obligation for financial statement 

reporting purposes.

A postal official has expressed concern that accrual accounting for this 

obligation would result in immediate rate increases of significant 

magnitude. We recognize that such an approach may initially result in 

higher rate increases than would otherwise be the case under a pay-as-yougo basis; however, rate increases would likely be more moderate in the 

longer term. Various options may exist for addressing the effect of 

recognizing this obligation, including possible amortization of any current 

unfunded obligation over a reasonable time period, such as 20-40 years. To 

further explore these options, we believe that the Service should work with 

the Postal Rate Commission and other appropriate stakeholders to 

determine options for phasing in any potential effect on postal rates. 

16See U.S. General Accounting Office, U.S. Postal Service: Accounting for Postretirement 

Benefits, GAO-02-916R (Washington, D.C.: Sept. 12, 2002).
Page 29 GAO-04-238 Postal Pension Funding Reform

We will be assessing the impact of the accounting treatment for the retiree 

health benefits obligation for whichever proposal is adopted, as well as for 

the Service’s pension obligation, as part of our ongoing work. 

Conclusions The Service faces an uncertain future. First-Class Mail volume continues to 

decline, and new revenue sources are not apparent. The Service faces 

significant unfunded obligations, the largest of which is for retirees, which 

must be addressed. Further, decisions must be made as to whether current 

or future ratepayers, or taxpayers, should be responsible for paying these 

obligations. The Service has acknowledged that it needs to reduce its 

operating costs to deal with the decline in First-Class Mail volume and meet 

its obligations. The most direct way for the Service to do this is to become 

more efficient by standardizing its operations and reducing excess capacity 

in its network as part of an integrated strategy to rationalize its 

infrastructure and workforce. The Service has stated that it plans to reduce 

its debt and finance capital investment necessary to transform itself from 

rate increases within the rate of inflation. It also proposes to prefund at 

least some of its retiree health benefits obligation. However, it is not clear 

based upon available information from the Postal Service whether it can 

accomplish these goals. If sufficient funding for transformation initiatives 

is not available, or if it does not achieve additional cost savings, significant 

additional efficiency gains may not be achieved. In addition, if larger postal 

rate increases are needed, further declines in mail volume could result. 

These scenarios could thereby threaten the Service’s future financial 

viability.

It is against this backdrop of fairness to current and future ratepayers and 

taxpayers, affordability, and the ability of the Service to achieve its 

transformation goals that the Service’s proposal to eliminate the escrow 

requirement and its two funding proposals must be weighed. We believe 

that the continuation of the escrow requirement after fiscal year 2005 

without allowing the Service to use the funds has the potential for 

significantly raising postal rates unnecessarily. Rate increases of the 

magnitude necessary to fund this escrow requirement in the future may 

precipitate further declines in mail volume and could hinder the Service’s 

ability to achieve other financial goals. Furthermore, Congress has other 

means by which it can direct or guide the Service in its use of funds if it 

chooses to do so.

Both funding proposals presented by the Service are generally consistent 

with the provisions of P.L. 108-18. Proposal I, which is preferred by the 
Page 30 GAO-04-238 Postal Pension Funding Reform

Service, hinges on transferring the responsibility for military service 

pension costs from the Service to the Treasury. Proposal I would result in a 

greater postal rate increase and would shift more of the responsibility for 

the retiree health benefits obligation to current ratepayers. Proposal II, on 

the other hand, would require less of a postal rate increase, focus more on 

rate mitigation, and shift less of the responsibility for the retiree health 

benefits obligation to current ratepayers than Proposal I. This would leave 

future postal ratepayers with more of the burden of paying for costs 

unrelated to products and services they receive.

Under both proposals, a portion of the retiree health benefits obligation 

would remain unfunded, and the Service currently does not intend to 

account for or report on its retiree health benefits obligation on an accrual 

basis under either proposal. Thus, the full extent of the Service’s obligation 

would not be recognized on its financial statements. Finally, the Service 

anticipates that it will be able to pay down debt and fund capital 

investments through inflation-based rate increases under both proposals. 

In our view, the Service needs to begin addressing its retiree health benefits 

obligation as soon as it can afford to do so, and to the extent it can. The 

most substantive way it will be able to do this, as well as enhance its overall 

financial viability, is by effectively implementing the transformation goals it 

and the President’s Commission set forth, particularly by becoming more 

efficient and rationalizing its infrastructure and workforce. It is therefore 

critical for the Service to have the capital funding needed for 

transformation. Although the Service believes it would be able to generate 

enough funds, this is not clear because the Service has not yet presented a 

comprehensive integrated infrastructure and workforce rationalization 

plan. However, the Service has agreed to do so, as well as report 

periodically on its progress in implementing its Transformation Plan. 

Finally, a number of technical issues need to be considered that are 

associated with the Service’s two funding proposals, including the 

implementation of any prefunding of the Service’s retiree health benefits 

obligation and the manner in which the Service should amortize and report 

on its obligation.

Matters for 

Congressional 

Consideration

To ensure continuing progress in addressing the Service’s financial 

challenges, we suggest that Congress consider the following:

• Repealing the escrow requirement after receiving an acceptable plan 

from the Service describing how it intends to rationalize its 

infrastructure and workforce and is confident that the Service is making 
Page 31 GAO-04-238 Postal Pension Funding Reform

satisfactory progress on transforming itself into a more efficient 

organization and implementing its transformation goals. 

• Directing the Service to fund specific purposes that Congress believes 

are especially important—such as prefunding the retiree health benefits 

obligation or supporting and possibly accelerating the Service’s 

transformation efforts—if the Service does not provide an acceptable 

plan for rationalizing its infrastructure and workforce, or show 

satisfactory progress in implementing transformation, or if Congress 

wants greater assurance that the Service will spend funds in a particular 

manner. In this regard, we have already recommended that the Service 

provide periodic reports on the status of its transformation initiatives 

and other Commission recommendations.

• Addressing implementation issues related to the retiree health benefits 

obligation. For example, one key issue that would need to be further 

explored is what options may be available that will allow the Service to 

amortize its unfunded retiree health benefits obligation over a specified 

time period (e.g., 20-40 years) and prefund the retiree health benefits 

obligation for future retirees.

Agency Comments and 

Our Evaluation

The Postal Service provided comments on a draft of this report in a letter 

from the Chief Financial Officer dated November 21, 2003. These 

comments are summarized below and reproduced in appendix II. The 

Service’s letter stated the following:

• It was pleased that our report found its proposals to be consistent with 

P.L. 108-18, and that its preferred proposal presented a more equitable 

balance of costs between current and future ratepayers. 

• It would have to raise rates to generate funds for the escrow 

requirement. 

• The issue of the affordability of the proposals should be viewed as a 

question of whether the ratepayers can afford them.

• It was concerned with our recommendation that Congress repeal the 

escrow requirement after it receives an acceptable plan from the Service 

concerning rationalization of its infrastructure and workforce, and if 

Congress believes that the Service is making satisfactory progress on its 

transformation goals. 
Page 32 GAO-04-238 Postal Pension Funding Reform

• The Service believes that it already provides adequate information to 

Congress for reviewing its plans and progress on transformation. Thus, 

the Service believes that using the escrow as an oversight mechanism is 

not necessary and will result in forcing the Service to raise rates.

• It believes that its Proposal I is in the best interest of the taxpayers and 

postal stakeholders.

In response to the Service’s comment regarding the affordability issue, we 

agree that affordability to ratepayers is an important consideration and 

discuss the impact of these proposals on rate increases and volume. We 

have also added language to our report to clarify this point. 

Regarding the Service’s concern about tying the escrow requirement to an 

acceptable infrastructure and workforce rationalization plan, we 

understand the Service’s concern that if the escrow requirement is not 

repealed, it would have to raise rates unnecessarily. We agree that 

establishing an escrow account without allowing the Service to use the 

funds would not be a desirable outcome, and that is one of the reasons why 

we suggested that Congress consider repealing the escrow requirement. On 

the other hand, contrary to the Service’s view, we believe the escrow 

requirement is an opportunity for Congress to review how the Service plans 

to address a number of long-term challenges, including debt repayment, 

capital projects, an unfunded retiree health benefits obligation, and its 

progress toward transformation. If the Service provides Congress with an 

acceptable plan in the next several months and Congress finds the plan and 

the Service’s transformation progress satisfactory, we believe Congress 

should have sufficient time to repeal the escrow requirement so that an 

escrow account would not be needed. Thus, the Service would not have to 

include the operating expense associated with the escrow requirement in 

its rate base for the next rate case filing. Alternatively, if Congress is not 

satisfied, it could direct the Service to fund specific activities or purposes 

through means other than an escrow requirement.

Finally, the Service believes that using the escrow requirement for 

additional oversight is not needed, because it has provided Congress with 

adequate information on its plans and progress toward transformation. 

While we agree that the Service provides a variety of reports and plans to 

Congress, including its November 2003 Transformation Plan Progress 

Report, the Service has not provided Congress with a comprehensive and 

integrated infrastructure and workforce rationalization plan. We believe 

such a plan is needed because the Service’s rationalization of its 
Page 33 GAO-04-238 Postal Pension Funding Reform

infrastructure and workforce is among the most important initiatives in the 

Service’s Transformation Plan since it will significantly affect the Service as 

well as so many employees, mailers, and communities. Recognizing the 

widespread interest and potential controversy associated with any changes 

in this area, it is critical that the Service inform Congress and the public 

about its rationalization strategies and plans. We, as well as the President’s 

Commission, believe that these initiatives are also key to the Service’s 

efforts to cut costs and become more efficient. Accordingly, we believe 

oversight in this area is necessary, and that information related to the cost 

of these initiatives and the Service’s ability to fund them will be needed to 

assure Congress that the Service is continuing to make progress in 

implementing its Transformation Plan. 

We will send copies of this report to the Chairmen and Ranking Minority 

Members of the House and Senate Committees on Appropriations, as well 

as Representative John M. McHugh, Chairman of the House Special Panel 

on Postal Reform and Oversight; Representative Danny K. Davis, Senator 

Daniel K. Akaka, Senator Thomas R. Carper, the Postmaster General, the 

Secretary of the Treasury, the Director of the Office of Personnel 

Management, the Director of the Office of Management and Budget, the 

Chairman of the Postal Rate Commission, and other interested parties. We 

will also make copies available to others on request. In addition, this report 

will be available at no charge on GAO's Web site at http://www.gao.gov. 

Staff acknowledgments are included in appendix III. If you have any 

questions about this report, please contact Bernard L. Ungar, Director, 

Physical Infrastructure Issues, at (202) 512-2834 or at ungarb@gao.gov.

David M. Walker

Comptroller General of the United States
Page 34 GAO-04-238 Postal Pension Funding Reform

Appendix I

Objectives, Scope, and Methodology AAppenednxidexiIs

Our objectives for this report were to fulfill our legislative mandate to 

evaluate the Postal Service’s proposal for use of the savings accruing to the 

Service from enactment of pension reform legislation. We evaluated the 

report based on its consistency with P.L. 108-18. We also addressed the 

escrow requirement that the Service identified as an issue in its report, and 

identified issues based upon our previous work that Congress may want to 

consider in assessing the Service’s proposals, including the fairness and 

affordability of the proposals, and the ability of the proposals to help the 

Service achieve its transformation goals. Finally, we discussed other 

pertinent issues that we identified in the course of our review. 

To assess whether the proposals were consistent with the provisions of P.L. 

108-18, we reviewed the legislative history of P.L. 108-18. We then assessed 

how well each of these proposals addressed the Sense of Congress and the 

Matters to Consider expressed in that legislation. We also reviewed the 

Commission recommendations to determine if the proposals were 

consistent with this work.

To assess the escrow requirement, we reviewed the Service’s report, 

interviewed postal officials, and analyzed the Postal Service’s financial data 

to assess the impact of the escrow requirement on the Service’s financial 

situation. We also interviewed congressional staff to discuss the purpose of 

this account.

To identify issues we had previously reported on, we reviewed our previous 

work. To assess how well each proposal addressed fairness issues, we 

reviewed Postal Service documents and interviewed Postal Service 

officials. We also assessed the affordability of each proposal by obtaining 

and analyzing Postal Service documents, including the Five-Year Strategic 

Plan FY 2004-2008, the Integrated Financial Plan for Fiscal Year 2004, the 

Five-Year Strategic Capital Investment Plan 2004-2008, annual reports, and 

materials provided by the Service in support of its proposals. We did not 

independently verify any of the financial data provided by the Postal 

Service. We also reviewed actuarial reports regarding the retiree health 

benefits obligation, and analyzed the Service’s proposed funding 

mechanism. We did not independently verify any of the actuarial reports. 

We also reviewed the Service’s April 2002 Transformation Plan to assess 

progress in this area. To assess the impact on the federal budget, we 

reviewed the federal budget and documents prepared by the Congressional 

Budget Office related to the effect of P.L. 108-18 on the federal budget, and 

we conducted interviews with officials from the Congressional Budget 

Office. 
Appendix I

Objectives, Scope, and Methodology

Page 35 GAO-04-238 Postal Pension Funding Reform

To identify other pertinent issues that Congress may want to consider, we 

reviewed Postal Service documents, the Commission’s report, and our 

previous work. We also conducted interviews with congressional staff, 

OPM, and Postal Service officials.

The Service raised another issue in its report that was not within the scope 

of our review. The Service has expressed concern with the method that 

OPM used to determine the amount of the postal CSRS fund. The Service 

believes that OPM’s methodology assigns an unreasonably low portion of 

the retirement benefit to the federal government, so it provided OPM with 

two alternatives to consider. OPM did not agree with the first alternative 

and did not respond to the second alternative. P.L. 108-18 required OPM, in 

consultation with the Postal Service, to develop the methodology used to 

determine the amount of the postal CSRS fund. The law also afforded the 

Service the opportunity to appeal OPM’s methodology to the Board of 

Actuaries of the Civil Service Retirement System, which the Service is 

currently considering. Thus, we did not include this issue in the scope of 

our review.

We conducted our review at Postal Service headquarters in Washington, 

D.C., from October 1, 2003, through November 25, 2003, in accordance with 

generally accepted government auditing standards. 
Page 36 GAO-04-238 Postal Pension Funding Reform

Appendix II

Comments from the U.S. Postal Service ApendxiI
Appendix II

Comments from the U.S. Postal Service

Page 37 GAO-04-238 Postal Pension Funding Reform
Page 38 GAO-04-238 Postal Pension Funding Reform

Appendix III

GAO Contact and Staff Acknowledgments ApendxiI

GAO Contact Bernard L. Ungar, (202) 512-2834.

Staff 

Acknowledgments

Teresa L. Anderson, Alan N. Belkin, Christine Bonham, Margaret Cigno, 

Nikki Clowers, Kathy Gilhooly, and Kenneth E. John made key 

contributions to this report.

(543081)
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