Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules
Published: 2005-05-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Pension funding rules are intended to ensure that plans have sufficient assets to pay promised benefits to plan participants. However, recent terminations of large underfunded plans, along with continued widespread underfunding, suggest weaknesses in these rules that may threaten retirement incomes of these plans' participants, as well as the future viability of the Pension Benefit Guaranty Corporation (PBGC) single-employer insurance program. We have prepared this report under the Comptroller General's authority, and it is intended to assist the Congress in improving the financial stability of the defined benefit (DB) system and PBGC. We have addressed this report to each congressional committee of jurisdiction to help in their deliberations. This report examines: (1) the recent funding and contribution experience of the nation's largest private DB plans; (2) the funding and contribution experience of large underfunded plans, and the role of the additional funding charge (AFC); and (3) the implications of large plans' recent funding experiences for PBGC, in terms of risk to the agency's ability to insure benefits.
section_title: What GAO Found
paragraphs: Each year from 1995 to 2002, while most of the largest DB pension plans had assets that exceeded their current liabilities, 39 percent of plans on average were less than 100 percent funded. By 2002, almost one-fourth of the 100 largest plans were less than 90 percent funded. Further, because of leeway in the actuarial methodology and assumptions sponsors may use to measure plan assets and liabilities, underfunding may actually have been more severe and widespread than reported. Additionally, 62.5 percent of sponsors of the largest plans each year on average made no cash contribution because the rules allow sponsors to satisfy minimum funding requirements through plan accounting credits that substitute for cash contributions. From 1995 to 2002, only 6 unique plans in our sample were subject to an additional funding charge (AFC), the primary funding mechanism to address underfunding, a total of 23 times. By the time a firm was subject to an AFC, its plan was likely significantly underfunded, and such plans remained poorly funded. By using other funding credits, just over 30 percent of the time sponsors of these plans were able to forgo cash contributions in the years their plans were assessed an AFC. Two very large and significantly underfunded plans terminated without their sponsors owing a cash contribution in the 3 years prior to termination, illustrating further weaknesses in the AFC. To the extent that financially weak firms sponsor underfunded plans, weaknesses in funding rules create a potentially large financial risk to PBGC and thus retirement security generally. From 1995 to 2002, on average each year, 9 of the largest 100 plans had a sponsor with a speculative grade credit rating, suggesting financial weakness and poor creditworthiness. Plans of speculative grade-rated sponsors had lower average funding levels and were more likely to incur an AFC than other plans. As of September 30, 2004, PBGC estimated that plans of financially weak companies with a "reasonably possible" chance of termination had plans with an estimated $96 billion in underfunding.

section_title: Letter
paragraphs: The Pension Benefit Guaranty Corporation’s (PBGC) single-employer  insurance program is a federal program that insures certain benefits of the  more than 34 million worker, retiree, and separated vested participants of  over 29,000 private sector defined benefit (DB) pension plans. In recent  years, because of unfavorable economic conditions and the collapse of  large underfunded pension plans sponsored by well-known firms like  Bethlehem Steel, U.S. Airways, and United Airlines, the program’s  financial condition has worsened significantly. From a $9.7 billion surplus  at the end of fiscal year 2000, the program reported a $23.3 billion deficit  as of September 2004, including a $12.1 billion loss for fiscal year 2004. In  addition, financially weak firms sponsored DB plans with a combined   $96 billion of underfunding as of September 2004, up from $35 billion as of  2 years earlier. These figures illustrate both PBGC’s current financial  difficulties and the ongoing threat underfunded DB pension plans pose to  the agency.
The Employee Retirement Income Security Act of 1974 (ERISA), as  amended, and the Internal Revenue Code (IRC) prescribe pension funding  rules to determine how much a firm sponsoring a DB pension plan (or  “sponsor”) must contribute to its plans each year. An amendment to  ERISA and the tax code added the additional funding charge (AFC), a  supplementary charge assessed to sponsors of certain underfunded plans.  While these funding rules seek to ensure that plans contain sufficient  assets to pay promised pension benefits to plan participants, recent  terminations of large and severely underfunded pension plans have called  into question their effectiveness.
We have prepared this report under the Comptroller General's authority,  and it is intended to assist the Congress in improving the financial stability  of the defined benefit system and PBGC. As it may prove helpful in the  deliberations of committees with jurisdiction over pension issues, we have  addressed this report to each of these committees. In previous reports, we  have called for comprehensive DB pension reform that, among other  elements, would include changes to the current funding rules to encourage  firms to better, and more transparently, fund their plans. We have also  called for a range of PBGC insurance program and other related reforms.  Because of the risks facing the single-employer program, in July 2003 we  placed the program on our high-risk list of government operations facing  significant vulnerabilities. Further, there are parallels between the  financial problems of the DB pension system and those of Social Security,  currently the focus of domestic public policy debate, as well as the  broader long-term budgetary challenges facing the federal government.
To assess how well the minimum funding rules have performed and to  better understand how key rules work to protect plans from becoming  severely underfunded, we will address the following issues: (1) the recent  trend in funding and contribution behavior for the nation’s largest private  DB plans, (2) the funding and contribution experience of large  underfunded plans and the role of the AFC, and (3) the implications of  large plans’ recent funding experience for PBGC, in terms of risk to the  agency’s ability to insure benefits.
Our analysis focused on DB pension data for the 100 largest plans as  ranked by current liabilities reported on Schedule B of the Form 5500  each year from 1995 to 2002, as well as on financial information on  sponsors of these large plans. For details on our scope and methodology,  please see appendix I. Our work was done in accordance with generally  accepted government auditing standards from November 2003 to May  2005.
subsections: section_title: Background
paragraphs: In DB plans, formulas set by the employer determine employee benefits.  DB plan formulas vary widely, but benefits are frequently based on  participant pay and years of service, and typically paid upon retirement as  a lifetime annuity, or periodic payments until death. Because DB plans  promise to make payments in the future, and because tax-qualified DB  plans must be funded, employers must use present value calculations to  estimate the current value of promised benefits. The calculations require  making assumptions about factors that affect the amount and timing of  benefit payments, such as an employee’s retirement age and expected  mortality, and about the expected return on plan assets, expressed in the  form of an interest rate. The present value of accrued benefits calculated  using mandated assumptions is known as a plan’s “current liability.”  Current liability provides an estimate of the amount of assets a plan needs  today to pay for promised benefits.
Before the enactment of ERISA, few rules governed the funding of DB  pension plans, and participants had little assurance that they would  receive the benefits promised. ERISA, and several amendments to the law  since its passage, established minimum funding requirements for sponsors  of pension plans in order to try to ensure that plans contain enough assets  to pay promised benefits. In principle, a sponsor must annually fund the  amount required to fund the plan’s “normal cost,” the amount of earned  benefits allocated during that year, plus a specified portion of other  liabilities that may be amortized over a period of years.
Compliance with the minimum funding requirements is recorded through  the plan’s funding standard account (FSA). The FSA tracks events that  affect the financial health of a plan during that plan year: credits, which  reflect improvements to the plan’s assets, such as contributions, amortized  experience gains, and interest; and charges, which reflect an increase in  the plan’s financial requirements, such as the plan’s normal cost and  amortized charges such as the initial actuarial liability, experience losses,  and increases in a plan’s benefit formula. If FSA credits exceed charges in  a given plan year, the plan’s FSA registers a net “credit balance” that may  be carried forward to the next plan year; conversely, a prior year’s funding  deficiency also carries forward. The FSA credit balance at year-end is  equal to the FSA credit balance at the beginning of the year plus FSA  credits less FSA charges.  Compliance with the minimum funding standard  requires that the FSA balance at the end of the year is non-negative. An  existing credit balance accrues interest and may be drawn upon to help  satisfy minimum funding requirements for future plan years, and therefore  may offset the need for future cash contributions.
ERISA and the IRC prescribe rules regarding the assumptions that  sponsors must use to measure plan liabilities and assets. For example, for  plan years 2004 and 2005, the IRC specifies that the interest rate used to  calculate a plan’s current liability must fall within 90 to 100 percent of the  weighted average of the rate on an index of long-term investment-grade  corporate bonds during the 4-year period ending on the last day before the  beginning of the plan year. Similarly, rules dictate that sponsors report an  “actuarial” value of assets that must be based on reasonable assumptions  and must take into account the assets’ market value. This value may  differ in any given year, within a specified range, from the current market  value of plan assets, which plans also report. While different assumptions  will change a plan’s reported assets and liabilities, sponsors eventually  must pay the amount of benefits promised; if the assumptions used to  compute current liability differ from the plan’s actual experience, current  liability will differ from the amount of assets actually needed to pay  benefits.
Funding rules generally treat a plan as an ongoing entity, and plans do not  necessarily have to maintain an asset level equal to current liabilities every  year. However, the funding rules include certain mechanisms that are  intended to keep plans from becoming too underfunded. One such  mechanism is the AFC, introduced by the Omnibus Budget Reconciliation  Act of 1987 (OBRA ‘87). The AFC requires sponsors of plans with more  than 100 participants that have become underfunded to a prescribed level  to make additional plan contributions in order to prevent funding levels  from falling too low. With some exceptions, plans with an actuarial value  of assets below 90 percent of current liabilities are affected by the AFC  rules. The rules for determining the amount of the AFC are complex, but  they generally call for sponsors to pay a percentage of their unfunded  liability. Under current law, plans that owe an AFC may still apply FSA  credits to meet their funding obligation and therefore may not be required  to satisfy the AFC with a cash contribution.
In addition to setting funding rules, ERISA established PBGC to guarantee  the payment of the pension benefits of participants, subject to certain  limits, in the event that the plan could not. Under ERISA, the termination  of a single-employer DB plan may result in an insurance claim with the  single-employer program if the plan has insufficient assets to pay all  benefits accrued under the plan up to the date of plan termination. PBGC  may pay only a portion of a participant’s accrued benefit because ERISA  places limits on the PBGC benefit guarantee. For example, PBGC generally  does not guarantee benefits above a certain amount, currently $45,614  annually per participant at age 65. Additionally, benefit increases arising  from plan amendments in the 5 years immediately preceding plan  termination are not fully guaranteed, although PBGC will pay a portion of  these increases. Further, PBGC’s benefit guarantee is limited to the  monthly straight life annuity benefit the participant would receive if she  were to commence the annuity at the plan’s normal retirement age.  Sponsors of PBGC-insured DB plans pay annual premiums to PBGC for  their coverage. Premiums have two components: a per participant charge  paid by all sponsors (currently $19 per participant), and a “variable-rate”  premium that some underfunded plans pay based on the level of unfunded  benefits.
Despite the presence of minimum funding rules and the AFC, plan  underfunding has persisted. In recent years, the level of total plan  underfunding has increased rapidly, from about $39 billion in 2000 to an  amount estimated to exceed $450 billion as of September 30, 2004. While  the single-employer program has over $39 billion in assets to pay benefits  in the near term, it already faces liabilities of over $62 billion. Thus, there  is concern that the expected continued termination of large plans by  bankrupt sponsors will push the program more quickly into insolvency,  generating greater pressure on the Congress, and ultimately the taxpayers,  to provide PBGC financial assistance to avoid reductions in guaranteed  payments to retirees. Because of concerns about the long-term viability  of the single-employer program, as illustrated by its growing accumulated  deficit (see fig. 1), in July 2003 we placed the program on GAO’s high-risk  list of agencies and programs that need broad-based transformations to  address major challenges. In October 2003, we identified several  categories of reform that the Congress might consider to strengthen the  program over the long term. We concluded that the Congress should  consider comprehensive reform measures to reduce the risks to the  program’s long-term financial viability. These suggested reforms included  strengthening funding rules, along with possibly modifying program  guarantees; restructuring PBGC premiums; improving the transparency of  plan and program information; and certain other reforms.
GAO has a statutory responsibility for auditing the overall financial  position of the executive branch of the U.S. government. In a recent  report, we describe the serious challenges facing the nation from current  fiscal policies that, if unchecked, will lead to large, escalating, and  unsustainable budget deficits. This fiscal challenge stems in part from  increasing obligations of retirement-related programs like Social Security,  which faces long-term financial insolvency because of increased life  expectancy. Improvements in life expectancy have extended the average  amount of time spent by workers in retirement, from 11.5 years in 1950 for  the average male worker to 18 years as of 2003.
In February 2005, the Administration proposed several measures designed  to strengthen funding for single-employer DB pension plans. The main  elements of reform include (1) reforming the funding rules to ensure that  sponsors keep their retirement promises; (2) improving disclosure to  workers, investors, and regulators about pension plan status; and   (3) reforming premiums to better reflect a plan’s risk and restoring the  PBGC to financial health. The Administration asserts that such changes  would shore up the structural problems in the DB system and strengthen  the system’s financial health.
section_title: Many of the 100 Largest Plans’ Liabilities Exceeded Plan Assets from 1995 to 2002, and Few Sponsors Were Required to Make Cash Contributions
paragraphs: From 1995 to 2002, while most of the 100 largest plans had sufficient  assets to cover their plan liabilities, many did not. On average, each year  39 of these plans were less than 100 percent funded, and 10 had assets  below 90 percent of their current liabilities. Reported funding levels for  the group generally were stable and strong from 1996 to 2000, but they  worsened somewhat in 2001 before deteriorating noticeably in 2002.  Furthermore, because of leeway in the actuarial methodology and  assumptions sponsors may use to measure plan assets and liabilities,  underfunding may actually have been more severe and widespread than  reported at the end of the period. Because of flexible funding rules  permitting the use of accounting credits other than cash contributions to  satisfy minimum funding obligations, on average 62.5 of the 100 largest  plans each year received no cash contributions from their sponsors,  including 41 percent of plans that were less than 100 percent funded.
subsections: section_title: Many Plans Each Year Were Underfunded, and More Became Underfunded in Recent Years
paragraphs: The 100 largest plans each year from 1995 to 2002 contained mostly well- funded plans. However, on average 39 of these plans each year were less  than 100 percent funded; that is, for these plans, current liabilities  exceeded the reported actuarial value of assets in the plan. An average of  10 plans each year had asset levels below 90 percent of their current  liability, and 3 plans were less than 80 percent funded (see fig. 2).
As a group, funding levels among the 100 largest plans were reasonably  stable and strong from 1996 to 2000. Except for 1999, in no year did more  than 39 plans have liabilities exceeding assets, and no more than 9 plans  each year were below 90 percent funded. In 2001 there were signs of  increased underfunding, and by 2002, more than half of the largest plans  were less than 100 percent funded, with 23 plans less than 90 percent  funded. Two factors in the deterioration of many plans’ finances were the  decline in stock prices and in interest rates. From 2000 to 2002, the  Standard & Poor’s (S&P) 500 stock index declined sharply each year.  Given that DB plans on average held approximately half of their assets in  stocks from 1995 to 2000, the decline in stock prices meant a sharp  decline in the value of many plans’ pension assets. In addition, over the  sample period, 30-year Treasury bond rates, which served as the  benchmark for the rate used by plans to calculate pension liabilities,  generally fell steadily, raising liabilities. The combination of lower asset  values and higher pension liabilities had a serious adverse effect on overall  defined benefit funding levels.
section_title: Rules May Allow Reported Funding Levels to Overstate Current Funding Levels
paragraphs: Accurate measurement of a plan’s liabilities and assets is central to the  sponsor’s ability to maintain assets sufficient to pay promised benefits, as  well as to the transparency of a plan’s financial health. Because many  plans chose allowable actuarial assumptions and asset valuation methods  that may have altered their reported liabilities and assets relative to  market levels, it is possible that funding over our sample period was  actually worse than reported for a number of reasons. These include the  use of above-market rates that differ from market values and the use of  actuarial asset values that may differ from current asset values. Two large  plans that terminated in 2002 illustrate the potential discrepancies  between reported and actual funding.
subsections: section_title: Use of an Above-Market Interest Rate to Calculate Liabilities
paragraphs: Reported current liabilities are calculated using a weighted average of  rates from the 4-year period before the plan year. This weighting offers  sponsors the advantage of being able to smooth fluctuations in liabilities  that sharp swings in interest rates would cause, thereby reducing volatility  in minimum funding requirements and making funding more predictable.  However, the weighting reduces the accuracy of liability measurement  because the rate anchoring reported liabilities is likely to differ from  current market values. If the rates used to calculate current liabilities are  falling, this would have the effect of decreasing the rise in reported  liabilities associated with lower rates, making plans appear better funded  than they actually were. In a rising interest rate environment, the opposite  would be true. However, because rules allowed sponsors to measure  liabilities using a rate above the 4-year weighted average, sponsors could  reduce plan current liabilities compared with what their value would be if  calculated at current rates. The 4-year weighted average of the reference  30-year Treasury bond rate exceeded the current market rate in 76 percent  of the months between 1995 and 2002, and the highest allowable rate for  calculating current liabilities exceeded the current rate in 98 percent of  those months. Sponsors of the plans in our sample chose the highest  allowable interest rate to value their current liabilities 62 percent of the  time from 1995 to 2002.
section_title: Use of Actuarial versus Current Asset Values
paragraphs: Similarly, for assets, the actuarial value of assets used for funding may  differ from current market values. The actuarial value of assets cannot be  consistently above or below market, but in a given year may be anywhere  from 80 to 120 percent of market asset level. In our sample, 86 percent of  plans reported a different value for actuarial and market assets. On  average, using the market value instead of actuarial value of assets would  have raised reported funding levels by 6.5 percent each year. However,  while the market value exceeded actuarial value of assets during the late  1990s, when plan funding was generally strong, in the weaker funding year  of 2002 market assets dipped below actuarial assets. In 2001 and 2002,  calculating plan funding levels using market assets would have greatly  increased the number of plans below 90 percent funded each year. A  similar calculation for 2002 would have drastically increased the number  of large plans below 80 percent funded, from 6 to 24. Thus, we see some  evidence that using actuarial asset values lowered the volatility of reported  funding levels relative to those using market asset values. However, the  actuarial value of assets also may have disguised plans’ funded status as  their financial condition worsened.
section_title: Two Terminated Plans Showed Large Differences between Reported and Actual Funding
paragraphs: Some prominent recent plan terminations reveal some extreme  discrepancies between reported plan funding levels and market funding  levels. The Bethlehem Steel Corporation in 2002 reported that its plan was  85.2 percent funded on a current liability basis, yet the plan terminated  later that year with assets of less than half of the value of promised  benefits. The PBGC single-employer program suffered a $3.7 billion loss as  a result of that termination, its largest ever at the time. Similarly, LTV Steel  Company reported that its pension plan for hourly employees was over   80 percent funded on its Form 5500 filing for plan year 2001. When this  plan terminated in March, 2002, it had assets equal to 52 percent of  benefits, a shortfall of $1.6 billion.
section_title: Most Sponsors Most Years Made No Cash Contributions to Plans but Satisfied Funding Requirements through Use of Accounting Credits
paragraphs: For the 1995 to 2002 period, the sponsors of the 100 largest plans each  year on average made relatively small cash contributions to their plans.  Annual cash contributions for the 100 largest plans averaged  approximately $97 million on plans averaging $5.3 billion in current  liabilities. This average contribution level masks a large difference in  contributions between 1995 and 2001, during which period annual  contributions averaged $62 million (in 2002 dollars), and in 2002, when  contributions increased significantly to $395 million per plan. Further, in   6 of the 8 years in our sample, a majority of the largest plans made no cash  contribution to their plan (see fig. 3). On average each year, 62.5 plans  received no cash contribution, including an annual average of 41 percent  of plans that were less than 100 percent funded.
The funding rules allow sponsors to meet their plans’ funding obligations  through means other than cash contributions. If a plan has sufficient FSA  credits from other sources, such as an existing credit balance or large  interest or amortization credits, to at least match its FSA charges, then the  plan does not have to make a cash contribution in that year. Because  meeting minimum funding requirements depends on reconciling total  annual credits and charges, and not specifically on cash contributions,  these other credits can substitute for cash contributions.
From 1995 to 2002, it appears that many of the largest plan sponsors  substituted a significant amount of FSA credits for cash contributions. The  average plan’s credit balance carried over from a prior plan year totaled  about $572 million (2002 dollars) each year, and 88 percent of plans on  average carried forward a prior credit balance into the next plan year from  1995 to 2002. Not only could these accumulated credit balances help a plan  to meet minimum funding obligations in future years, but they also accrue  interest that further augments a plan’s FSA credits. In contrast to large  prior-year credit balances, annual cash contributions averaged only   $97 million, in 2002 dollars. On average each year, cash contributions  represented 90 percent of the minimum required annual funding (from  cash and credits). However, this average figure was elevated by high  levels of contributions by some plans in 1995, 1996 and 2002. From 1997 to  2000, when funding levels were generally strong, cash contributions  averaged only 42 percent of minimum required annual contributions (see  fig. 4). During these years, a majority of plans in our sample received no  cash contribution (see fig. 5). Cash contributions represented a smaller  percentage of annual minimum required funding during years when plans  were generally well funded, indicating that in these years more plans  relied more heavily on credits to meet minimum funding obligations.
In addition to large credit balances brought forward from prior years,  sponsors added funding credits from other sources. For example, plans  reported approximately $42 million (2002 dollars) each year in net interest  credits. These credits accrue to a plan’s FSA like interest on a bank  account, accruing to an existing credit balance at the beginning of the plan  year and to other credits, such as contributions, added during the plan  year. Rules also allow plans to accrue credits from the excess of a plan’s  calculated minimum funding obligation above the plan’s full funding  limitation; these credits averaged $47 million (2002 dollars) from 1995 to  2002. Other plan events result in plan charges, which reflect events that  increase the plan’s obligations. For example, plans reported annual  amortization losses, which could result from actual investment rates of  return on plan assets below assumed rates of return (including outright  losses) or increases in the generosity of plan benefits; these net  amortization charges averaged almost $28 million (2002 dollars) in our  sample. Total funding credits, offset by charges, may help satisfy a plan’s  minimum funding obligation, substituting for cash contributions, and may  explain why a significant number of sponsors made zero cash  contributions to their plans in many years.
section_title: FSA Accounting Rules Can Make Required Contributions Less Volatile but May Obscure Funded Status and Reduce Contributions
paragraphs: The FSA credit accounting system provides some advantages to DB plan  sponsors. Amortization rules require the sponsor to smooth certain events  that affect plan finances over several years, and accumulated credit  balances act as a buffer against swings in future funding requirements.  These features often allow sponsors to better regulate their annual level of  contributions. In contrast, contributions and funding levels might fluctuate  greatly from year to year if funding were based strictly on yearly  differences between the market value of plan assets and current liabilities.  Thus, a contribution system with an FSA accounting feature may make  funding requirements less volatile and contributions more predictable than  one in which funding was based entirely on current assets and liabilities.  Similarly, current-law measurement and funding rules provide a plan with  some ability to dampen volatility in required funding caused by economic  events that may sharply change a plan’s liabilities or assets. Pension  experts told us that this predictability and flexibility make DB sponsorship  more attractive to employers.
However, the FSA accounting system, by smoothing annual contributions  and liabilities, may distort a plan’s funding level. For example, suppose a  sponsor accrues a $1 million credit balance from making a contribution  above the required minimum in a year. Suppose then that this $1 million  purchases assets that lose all of their value by the following year. Even  though the plan no longer had this $1 million in assets, the sponsor could  still use that credit balance (plus interest on the credit balance) to reduce  this year’s contribution to the plan. Because of amortization rules, the  sponsor would have to report only a portion of that lost $1 million in asset  value as a plan charge the following year. Similarly, sponsors are required  to amortize the financial effect of a change in a plan’s benefit formula,  which might result in increased benefits and therefore a higher funding  obligation, over a 30-year period. Thus, even though higher benefits would  immediately raise a plan’s obligation to fund, the sponsor could spread  this effect in the plan’s FSA over 30 years. This disconnection between the  reported and current market condition of plan finances raises the risk that  plans will not react quickly enough to deteriorating plan conditions.  Further, it reduces the transparency of plan financial information to  stakeholders, such as participants, and investors.
The experience of two large plans that terminated in a severely  underfunded state help illustrate the potential disconnection between FSA  accounting and the plan’s true funded status. As stated earlier, the  Bethlehem Steel Corporation and LTV Steel Company both had plans  terminate in 2002, each with assets approximately equal to 50 percent of  the value of benefits. Yet each plan was able to forgo a cash contribution  each year from 2000 to 2002, instead using credits to satisfy minimum  funding obligations, primarily from large accumulated credit balances  from prior years. Despite being severely underfunded, each plan reported  an existing credit balance in 2002, the year of termination (see table 1).
section_title: Full Funding Limitation Rule May Have Allowed Some Plan Sponsors to Forgo Plan Contributions
paragraphs: Another possible explanation for the many instances in which sponsors  made no annual cash contribution regards the full funding limitation  (FFL). The FFL is a cap on minimum required contributions to plans that  reach a certain funding level in a given plan year. However, the FFL does  not necessarily represent the contribution that would raise plan assets to  the level of current liability. Between 1995 and 2002, rules permitted some  plans with assets as low as 90 percent of current liability to reach the FFL,  meaning that a plan could be considered fully funded without assets  sufficient to cover all accrued benefits. The FFL is also distinct from the  plan’s annual maximum tax-deductible contribution. Because sponsors  may be subject to an excise tax on contributions above the maximum, the  annual maximum contribution can act as a real constraint on cash  contributions. In contrast, the FFL represents a “maximum minimum”  contribution for a sponsor in a given year—a ceiling on the sponsor’s  minimum funding obligation for the plan.
Flexibility in the FFL rule has allowed many plan sponsors to take steps to  minimize their contributions. In our sample, from 1995 to 2002  approximately two-thirds of the sponsors in each year made an annual  plan contribution at least as large as the plan’s FFL. However, in 65  percent of these instances, the sponsor had chosen the highest allowable  rate to calculate current liability; using a lower rate to calculate current  liability may have resulted in a higher FFL, and therefore may have  required a higher contribution. Further, the FFL was equal to zero for   60 percent of plans each year, on average. This means that these plans  were permitted to forgo cash contributions as a result of the FFL rule. This  reflects the fact that if a plan’s FFL equaled zero, that plan had assets at  least equal to 90 percent of current liabilities that year and would not be  required to make an additional contribution.
The interaction between the FFL rule and the annual maximum tax- deductible contribution also has implications for the amount that plan  sponsors can contribute. In some years, the maximum deductible  contribution rules truly constrained some sponsors from making any cash  contribution. In 1998, 50 of 60 plans that contributed to the maximum  deductible amount had a maximum deductible contribution of zero (see  fig. 6). This meant that any cash contribution into those plans that year  would generally subject the sponsor to an excise tax. For 37 of these  plans, this was the case even if the sponsor had chosen the lowest  statutorily allowed interest rate for plan funding purposes, which would  have produced the highest calculated current liabilities. This constraint  did not apply to as many plans in some other years. For example, in 1996,  52 plans contributed the maximum deductible amount. Thirty of these  plans had a maximum deductible contribution of zero. However, 16 of  these 30 could have chosen a lower rate to raise their maximum  deductible contribution level.
section_title: Very Few Sponsors of Underfunded Large Plans Paid an AFC from 1995 to 2002
paragraphs: From 1995 to 2002, an average of only 2.9 of the 100 largest DB plans each  year were assessed an additional funding charge, the funding mechanism  designed to prevent severe plan underfunding, even though on average   10 percent of plans each year reported funding levels below 90 percent.  Over the entire 8-year period, only 6 unique plans that placed among the  100 largest plans in any year from 1995 to 2002 owed an AFC. These 6  plans owed an AFC during the period a total of 23 times in years in which  they were among the 100 largest plans, meaning that plans that were  assessed an AFC were likely to owe it again. On average, by the time a  plan was assessed an AFC, it was significantly underfunded and was likely  to remain chronically underfunded in subsequent years. Further, during  this period, 2 of these 6 plans that owed an AFC were terminated, each  with assets far below promised benefits and each without having had to  make a cash contribution in the 3 years prior to termination. As with plans  in general, funding rules allowed sponsors owing an AFC to use FSA  credits to help meet their funding obligations, in some years allowing  sponsors to forgo cash contributions altogether.
subsections: section_title: Few Plans Were Assessed an AFC, and These Plans Were Likely to Be Very Underfunded
paragraphs: Funding rules dictate that a sponsor of a plan with more than   100 participants in which the plan’s actuarial value of assets fall below   90 percent of liabilities, measured using the highest allowable interest rate,  may be liable for an AFC in that year. More specifically, a plan that is  between 80 and 90 percent funded is subject to an AFC unless the plan  was at least 90 percent funded in at least 2 consecutive of the 3 previous  plan years. A plan with assets below 80 percent of liabilities, calculated  using the highest allowable rate, is assessed an AFC regardless of its  funding history.
Despite the statutory threshold of a 90 percent funding level for some  plans to owe an AFC, in practice a plan needed to be much more poorly  funded to become subject to an AFC. While about 10 plans in our sample  each year had funding below 90 percent on a current liability basis, on  average fewer than 3 plans each year owed an AFC (see fig. 7). From 1995  to 2002, only 6 of the 187 unique plans that composed the 100 largest plans  each year were ever assessed an AFC, and these plans owed an AFC a  total of 23 times in years in which they were among the 100 biggest plans.  By the time a sponsor owed an AFC, its plan had an average funding level  of 75 percent, suggesting that by the time the AFC was triggered, the plan’s  financial condition was weak. Further, while we observed 60 instances  between 1995 and 2002 in which a plan had funding levels between 80 and  90 percent, only 5 times was a plan in this funding range subject to an  AFC. This would indicate that, in practice, 80 percent represented the  realistic funding threshold for owing or avoiding the AFC.
AFC rules specify a current liability calculation method that may overstate  actual plan funding, relative to using market measures, thereby reducing  the number of plans that might be assessed an AFC. To determine if a  sponsor owes an AFC, rules dictate that the sponsor calculate current  liability using the highest allowable interest rate, which results in a plan’s  lowest possible measure of current liability. Because the highest allowable  rate exceeded current market rates in 98 percent of the months from   1995 to 2002, this likely lowered current liability measures for AFC  purposes, which would cause fewer plans to be assessed an AFC. In our  sample, 5 plans that reported funding levels below 80 percent on a current  liability basis did not owe an AFC, perhaps because current liability does  not require the use of the highest allowable interest rate.
Sponsors that owed an AFC had mixed success at improving their plans’  financial conditions in subsequent years, and most of these plans remained  significantly underfunded. Among the 6 plans that owed the AFC at least  once, funding levels rose slightly from an average 75 percent when the  plan was first assessed an AFC to an average 76 percent, looking  collectively at all subsequent years. All of these plans were assessed an  AFC more than once, and 2 of the 6 plans terminated during the period,  each with a severe shortfall of assets relative to promised benefits,  creating large losses for PBGC’s single-employer insurance program.  Further, the AFC was an imperfect mechanism for improving funding of  these plans prior to termination. Bethlehem Steel, which terminated its  plan in 2002 with a funding level under 50 percent, was subject to an AFC  that year, but not from 1997 to 2001. LTV Steel, which terminated its  pension plan for hourly employees in 2002 with assets of $1.6 billion below  the value of benefits, did have its plan assessed an AFC each year from  2000 to 2002, but for only $2 million, $73 million, and $79 million, or no  more than 5 percent of the eventual funding shortfall. Despite these AFC  assessments, LTV contributed no cash to its plan during those years,  instead using credits to satisfy its funding obligations (see table 1).
section_title: Funding Rules Allow Underfunded Plans, Including Those Owing AFC, to Forgo Cash Contributions
paragraphs: While the formula to determine the amount is complex, the AFC equals  approximately 18 to 30 percent of the plan’s unfunded liability, with more  underfunded plans owing a higher percentage than less underfunded  plans. However, the funding rules allow sponsors to use other FSA  credits, in addition to cash contributions, to satisfy minimum funding  obligations, including the AFC. Among plans in our sample assessed an  AFC, the average annual AFC owed was $234 million, but annual  contributions among this group averaged $186 million, with both figures in  2002 dollars (see fig. 8). In addition, 61 percent of the time a plan was  subject to an AFC, the sponsor used an existing credit balance to help  satisfy its funding obligation. When it did so, the sponsor drew $283  million from the credit balance—well above what sponsors owing an AFC  contributed in cash, on average. Just over 30 percent of the time a plan  was assessed an AFC, the funding rules allowed the sponsor to forgo a  cash contribution altogether that year.
Again, terminated plans provide a stark illustration of weaknesses in the  rules’ ability to ensure sufficient funding. Bethlehem Steel’s plan was  assessed an AFC of $181 million in 2002, but the company made no cash  contribution that year, just as it had not in 2000 or 2001, years in which the  plan was not assessed an AFC. When the plan terminated in late 2002, its  assets covered less than half of the $7 billion in promised benefits.  Similarly, LTV Steel made no contributions to its plan from 2000 to 2002,  despite being assessed an AFC in each of those years. Both plans were  able to apply existing credits instead of cash to satisfy minimum funding  requirements.
section_title: Large Plans’ Sponsors’ Credit Ratings Appear Related to Certain Funding Behavior and Represent Risk to PBGC
paragraphs: The recent funding experiences of large plans, especially those plans that  are sponsored by financially weak firms, illustrate the limited effectiveness  of certain current funding rules and represent a potentially large implicit  financial risk to PBGC. From 1995 to 2002, on average, 9 percent of the  largest 100 plans had a sponsor with a speculative grade credit rating,  suggesting financial weakness and poor creditworthiness. As a group,  speculative grade-rated sponsors had lower average funding levels, and  were more likely to incur an AFC than other sponsors. In addition,  speculative grade-rated sponsors generally had a higher incidence of using  the highest legally allowable interest rate to discount reported plan  liabilities. Using a higher interest rate lowers a plan’s calculated current  liabilities and may lower the plan’s minimum funding requirement; to the  extent that this reduces contributions, using the highest allowable interest  rate may raise the chances of underfunding and raise the financial  exposure to PBGC. Of PBGC’s 41 largest claims since 1975 in which the  rating of the sponsor was known, 39 have involved plan sponsors that  were rated as speculative grade just prior to termination. Among these  claims, over 80 percent of plan sponsors were rated as speculative grade  10 years prior to termination. The future outlook is similar: plans  sponsored by companies with speculative grade credit ratings and  classified by PBGC as “reasonably possible” of termination represent an  estimated $96 billion in potential claims.
subsections: section_title: Speculative Grade Sponsors More Likely to Have Lower Funding Levels
paragraphs: The financial health of a plan sponsor may be key to plan funding  decisions because sponsors must make funding and contribution decisions  in the context of overall business operations. During our 1995 to 2002   sample period, we observed between 7 and 13 plans each year with  sponsors that had a speculative grade credit rating.
From 1995 to 2002, we observed that plans with speculative grade-rated  sponsors had lower levels of average funding compared with the average  for the 100 largest plans. For instance, the average funding of plans of  sponsors that were rated as speculative grade was 12 percentage points  lower on average than the funding level for all plans from 1995 to 2002   (see fig. 9). Applying an alternative measure of plan funding that used the  reported market value measure of plan assets, we obtained broadly similar  results. Plans of speculative grade-rated sponsors were also more likely  to be underfunded. From 1995 to 2002, each year, on average, 18 percent  of speculative grade-rated plans had assets that were below 90 percent of  current liability. Plans of nonspeculative grade-rated sponsors had just  over half this incidence, or an average of 10 percent of plans funded below  90 percent of current liability.
Large plans sponsored by firms with a speculative grade rating were also  more likely to incur an AFC. While speculative grade-rated sponsors  accounted for only 9 percent of all sponsors from 1995 to 2002, they  accounted for just over one-third (8 of 23) of all instances in which a  sponsor was required to pay an AFC. No high investment grade sponsors  (those rated AAA or AA) were required to pay an AFC for this period.  While the AFC is intended to be a backstop for underfunded plans, for our  sample, it affected only those plans that were rated A or lower. The AFC  may, to some extent, protect PBGC from additional losses so plans cannot  become even more underfunded, especially if the plan is at risk for  financial distress. However, to the extent that speculative grade-rated  sponsors are considered to pose a significant risk for near-term  bankruptcy, the AFC may not be an effective mechanism for improving a  plan’s funding level. Plan sponsors that are in financial distress are, by  definition, having difficulty paying off debts and may be ill equipped to  increase cash contributions to their plan. That is, the AFC itself may be a  symptom of plan distress rather than a solution to improve a plan’s  funding level. AAA or AA rated sponsors, on the other hand, were not  assessed an AFC from 1995 to 2002, as they likely had the financial  flexibility to increase contributions to avoid consistently falling below  funding levels that would have triggered the AFC.
Large plans with sponsors rated as speculative grade were generally more  likely to report current liabilities calculated by using the highest allowable  interest rate under the minimum funding rules. While a majority of  sponsors from all credit rating categories used the highest allowable  interest rate over the entire 1995 to 2002 period, speculative grade-rated  sponsors used the highest rate at an incidence 23 percentage points above  the incidence for all other plans in the sample (see fig. 10). The use of  higher interest rates likely lowers a plan’s reported current liability and  minimum funding requirement. To the extent that this depresses cash  contributions, such plans may have a higher chance of underfunding, thus  creating additional financial risk to PBGC.
section_title: Speculative Grade-Rated Sponsors Represent Greater Risks to PBGC
paragraphs: Financial strength of plan sponsors’ business operations has been a key  determinant of risk to PBGC. Financially weak sponsors are, by the nature  of the insurance offered by PBGC, likely to cause the most financial  burden to PBGC and other premium payers. For instance, PBGC typically  trustees a plan when a covered sponsor is unable to financially support the  plan, such as in the event of bankruptcy or insolvency. Current funding  rules, coupled with the presence of PBGC insurance, may create certain  incentives for financially distressed plan sponsors to avoid or postpone  contributions and increase benefits. Many of the minimum funding rules  are designed so that sponsors of ongoing plans may smooth contributions  over a number of years. Sponsors that are in financial distress, however,  may have a more limited time horizon and place other financial priorities  above “funding up” their pension plans. To the extent that moral hazard  from the presence of PBGC insurance causes financially troubled sponsors  to alter their funding behavior, PBGC’s potential exposure increases.
Underfunded plans sponsored by financially weak firms pose the greatest  immediate threat to PBGC’s single-employer program. PBGC’s best  estimate of the total underfunding of plans sponsored by companies with  credit ratings below investment grade and classified by PBGC as  reasonably possible to terminate was an estimated $96 billion as of  September 30, 2004 (see fig. 11).
PBGC’s claims experience shows that financially weak plans have been a  source of substantial claims. Of the 41 largest claims in PBGC history in  which a rating was known, 39 of the plan sponsors involved were credit  rated as speculative grade 3 years prior to termination (see fig. 12). These  claims account for 67 percent of the value of total gross claims on the  single-employer program from 1975 to 2004. Most of the plan sponsors  involved in these claims were given speculative grade ratings for many  more years prior to their eventual termination. Even 10 years prior to plan  termination, 33 of the 41 plan sponsors involved in the largest gross  claims, in which the rating of the sponsor was known, were rated as  speculative grade.
section_title: Conclusions
paragraphs: Widely reported recent large plan terminations by bankrupt sponsors and  the financial consequences for PBGC have pushed pension reform into the  spotlight of national concern. Our past work has shown that the roots of  these current pension problems are broad and structural in nature, and  that the private DB pension system requires meaningful and  comprehensive reform. The Administration has already presented a  proposal for reform and others may soon emerge from the Congress. While  the complexity of the challenges suggests a considerable debate ahead, the  emerging consensus that action needs to be taken may be cause for  optimism.
Our analysis here examines the effectiveness of certain funding rules and  suggests that these rules have contributed to the general underfunding of  pensions and, indirectly, to PBGC’s recent financial difficulties. The  persistence of a large number of underfunded plans, even during the  strong economic period of the late 1990s, implies that current funding  rules are not stringent enough to ensure that sponsors can fund their  pensions adequately. Perhaps even more troubling is that current rules for  measuring and reporting plan assets and liabilities may not reflect true  current values and may understate the funding problem. Further, the very  small number of sponsors of underfunded plans that pay the AFC indicates  that the rule needs to be strengthened if it is to serve as the primary  mechanism for shoring up assets in underfunded plans.
The current rules have the reasonable and important goals of long-term  funding adequacy and short-term funding flexibility so as to reduce annual  contribution volatility. However, our work shows that although the current  system permits flexibility, it also permits reported plan funding to be  inadequate, misleading, and opaque, and even so, funding and  contributions for some plans can still swing wildly from year to year. This  would appear not to serve the interest of any DB pension stakeholders  effectively. The challenge is determining how to achieve a balance of  interests: how to temper the need for funding flexibility with accurate  measurement, adequate funding, and appropriate transparency. Our work  shows that although the current system permits flexibility, it also permits  reported plan funding to be inadequate, misleading, and opaque, and even  so, funding and contributions for some plans can still swing wildly from  year to year. This would appear not to serve the interest of any DB pension  stakeholders effectively.
Despite flaws in the funding rules, our work here shows that most of the  largest plans appear to be adequately funded. Rules should acknowledge  that funding will vary with cyclical economic conditions, and even  sponsors who make regular contributions may find their plans  underfunded on occasion. Periodic and mild underfunding is not usually a  major concern, but it becomes a threat to workers’ benefits and to PBGC  when the sponsor becomes financially weak and the risk of bankruptcy  and plan termination becomes likely. This suggests that perhaps the  stringency of certain funding rules can be adjusted depending on the  financial strength of the sponsor, with stronger sponsors being allowed  greater latitude in funding and contributions than weaker sponsors that  might present a near-term bankruptcy risk. However, focusing more  stringent funding obligations on weak plans and sponsors is difficult in  that strong firms and industries can quickly become risky ones, and once  sponsors and plans become too weak, it may be difficult for them to make  larger contributions and still recover.
It should be noted also that while change in the funding rules is an  essential piece of the reform puzzle, it is certainly not the only piece.  Indeed, pension reform is a challenge precisely because of the necessity of  fusing together so many complex, and sometimes competing, elements  into a comprehensive proposal. Ideally, effective reform would  improve the accuracy of plan asset and liability measurement while  minimizing complexity and maintaining contribution flexibility;    develop a PBGC insurance premium structure that charges sponsors  fairly, based on the risk their plans pose to PBGC, and provides  incentives for sponsors to fund plans adequately;    address the issue of severely underfunded plans making lump-sum  resolve outstanding controversies concerning cash balance and other  hybrid plans by safeguarding the benefits of workers regardless of age;  and  improve plan information transparency for PBGC, plan participants,  unions, and investors in a manner that does not add considerable  burden to plan sponsors.
Developed in isolation, solutions to some of these concerns could erode  the effectiveness of other reform components or introduce needless  complexity. As deliberations on reform move forward, it will be important  that each of these individual elements be designed so that all work in  concert toward well-defined goals.
This reform effort should also be understood in the context of the  problems facing other components of retirement security and the federal  budget generally. For example, Social Security, Medicare, and Medicaid  serve the larger population of retired and disabled workers, many of  whom are also affected by DB reform. The demographic dynamics of  increased longevity in life and retirement affecting the DB system also  affect these other programs, intensifying existing fiscal pressures on the  federal budget. Thus, DB pension reform, with these other issues, has  important implications both for the distribution of retirement income for  current and future generations and for our overall success in addressing  these broader budgetary challenges.
Even with meaningful, carefully crafted reform, it is possible that some DB  plan sponsors may choose to freeze or terminate their plans. Sponsor exit  is a serious concern, given the important role DB plans play in providing  retirement security. However, this is a natural consequence of the inherent  trade-off that exists in a private pension system that on one hand depends  on voluntary plan sponsorship and on the other is tax subsidized and   backed by federal insurance in order to promote the retirement security of  our nation’s workers. The overarching goals of balanced pension reform,  and particularly of funding rule reform, should be to protect workers’  benefits by providing employers the flexibility they need in managing their  pension plans while also holding those employers accountable for the  promises they make to their employees.
section_title: Matters for Congressional Consideration
paragraphs: As we have noted in previous reports, the Congress should consider  broad pension reform that is comprehensive in scope and balanced in  effect. Along with changes in the areas of PBGC’s premium structure,  lump-sum distributions, shutdown benefits, and other areas, funding rule  changes should be an essential element of DB pension reform. Such  reform may result in a system with features very different from the  framework currently governing DB plans and PBGC. However, significant  reforms that would place the DB system and PBGC on a sounder financial  footing could also be enacted and could retain many of the features of the  current regulatory system. Should the Congress choose to move in this  latter direction, this report highlights certain areas where carefully crafted  changes could improve plan funding. Specifically, the Congress should  consider measures that include    Strengthening the additional funding charge. One way to do this  would be to consider raising the threshold levels of funding that trigger  the AFC so that any sponsor with a plan less than 90 percent funded  would have to make additional contributions. So that plans do not have  an incentive to fund just barely above 90 percent, additional  consideration may be given for a gradual phase-in of the AFC for plans  that are underfunded between 90 percent and 100 percent of current  liability. Requiring that financially weak plans that owe an AFC base  their contributions on termination liability rather than current liability  might add stringency to the minimum funding rules and might be  appropriate, since weak sponsors of underfunded plans present a  greater risk of distress termination to PBGC than other sponsors.  These reforms could be enacted singly or jointly, but each would  subject more plans to an AFC, and the reforms would shore up at-risk  plans before underfunding becomes severe.
Limiting the use of FSA credits toward meeting minimum  funding requirements. We have noted that some sponsors repeatedly  relied on FSA credits, such as a prior year credit balance or net interest  credits, to avoid making cash contributions to their plans, and that this  has been particularly problematic for underfunded plans prior to their  termination. While FSA credits may have the benefit of moderating  contribution volatility in the near term, they also have the weakness of  allowing the sponsors of severely underfunded plans to avoid cash  contributions and may contribute to volatility later. The Congress  should consider ways, even if it retains the FSA, to scale back the  substitution of credits for annual cash contributions.
While admittedly an extremely complicated matter, meaningful effective  reform must confront the issue of accurate measurement. We found that  that the measurement techniques of assets and liabilities that are  permitted under current funding rules can result in distortions masking  the true funding status of a plan and can permit sponsors to avoid making  plan contributions. Techniques that lead to misleading indicators of plan  health and impede information transparency are a disservice to all key  stakeholders; to plan participants in making retirement decisions; to  unions seeking to bargain in the interests of their members; to current and  potential shareholders in deciding where to invest; and finally to the  public, which is the ultimate protector of employee benefits.
section_title: Agency Comments
paragraphs: We provided a draft of this report to the Department of Labor, Treasury,  and PBGC. The Department of Labor and PBGC provided written  comments, which appear in appendix III and appendix IV. Both the  Department of Labor’s and PBGC’s comments generally agree with the  findings and conclusions of our report. Treasury did not provide written  comments. The Department of Labor, Treasury, and PBGC also provided  technical comments, which we incorporated as appropriate.
We are sending copies of this report to the Secretary of Labor, the  Secretary of the Treasury, and the Executive Director of the PBGC,  appropriate congressional committees, and other interested parties. We  will also make copies available to others on request. In addition, the report  will be available at no charge on GAO’s Web site at http://www.gao.gov.
If you have any questions concerning this report, please contact me at  (202) 512-7215. Contact points for our Office of Congressional Relations  and Public Affairs may be found on the last page of this report. GAO staff  who made contributions are listed in appendix V.
section_title: Appendix I: Scope and Methodology
paragraphs: To describe recent pension funding trends, we analyzed data from  Schedule B of the Form 5500. This schedule contains information on plan  assets, liabilities, contributions, funding standard account (FSA) credits  and charges, and additional funding charge (AFC) calculations.
Problems with the electronic data of the Form 5500 are well documented.  To mitigate problems associated with the data we used Form 5500  research data from the Pension Benefit Guaranty Corporation’s (PBGC)  Policy, Research and Analysis Department (PRAD). PRAD analysts  routinely and systematically correct the raw 5500 data submitted by plans,  and PRAD 5500 data are thought to be the most accurate electronic  versions. Although we did not independently audit the veracity of the  PRAD data, we performed routine data reliability checks. In instances  where the data reliability checks revealed inconsistencies, we contacted a  PRAD analyst to check and, if appropriate, correct the electronic data  using information provided to PRAD in hard copy.
For our analysis, we worked with a subset of the PBGC research data that  included the 100 largest plans, measured by current liability, annually from  1995 to 2002. In 2002, the most recent, nearly complete year of available  Form 5500 data, these 100 plans, with average liabilities per plan of   $6.7 billion and 94,000 participants, represented approximately 50 percent  of the total liabilities and about 28 percent of the total participants of the  approximately 30,000 defined benefit (DB) plans that filed a Form 5500 for  plan year 2002 as of February 2005. Thus, while our sample data set  represents only a small portion of the total plans in the single-employer  program, it constitutes a significant proportion of the liabilities of the DB  system and the financial risk to PBGC while allowing for more manageable  analysis. We did not directly test or compare our sample for  generalizability across the entire sample of single-employer plans.
For 1999 and 2002, the best available data do not contain all possible  plans, and therefore it is possible that in those years complete data sets  would yield slightly different samples for our analysis. The 1999 data we  received from PBGC came from a sample that was missing an estimated  2,927 of the 37,536 plans in the single-employer program, because of  missing electronic records in that year. The 2002 data came from a sample  still missing approximately 300 plans, because of ongoing processing. We  believe that neither of these factors significantly affects our findings or our  conclusions.
To identify how the AFC is calculated and applied, we studied how the  relevant Employee Retirement Security Act of 1974 (ERISA) and Internal  Revenue Code (IRC) funding rules are applied, conducted a literature  review, and interviewed researchers, government officials, pension  actuaries, and pension sponsor groups familiar with pension funding rules.  To analyze potential risk to PBGC, we matched sponsor credit ratings  from the Standard and Poor’s (S&P) COMPUSTAT database, provided to  us by PBGC, to the sponsor’s pension plan data. PBGC also provided us  with detailed calculations to determine plans’ full funding limitations for  purposes of the minimum funding requirements. Additionally, to analyze  effects of maximum deductible contributions, we matched the results from  a previously issued PBGC study on the subject to our sample of plans. Our  work was done in accordance with generally accepted government  auditing standards.
section_title: Appendix II: Statistics for Largest 100 Defined Benefit Plans, 1995-2002
paragraphs: Appendix II: Statistics for Largest 100  Defined Benefit Plans, 1995-2002 (Dollar figures in millions of 2002 dollars)
Number of participants (actual)
Plans below 100% funded  Plans below 90% funded  Plans below 80% funded  Funding gap, plans below 100% funded  Plans using highest allowable interest rate  to calculate liabilities  Median figures reported are the average of individual year median values.
For analysis, each year contains that year’s 100 largest plans, ranked by current liabilities. From 1995  to 2002, 187 unique plans appear in at least 1 year’s sample of 100 largest plans. See footnote 9 in  main text for further explanation.  (Dollar figures in millions of 2002 dollars)
Underfunded plans receiving no cash contribution  Median figures reported are the average of individual year median values.
For analysis, each year contains that year’s 100 largest plans, ranked by current liabilities. From 1995  to 2002, 187 unique plans appear in at least 1 year’s sample of 100 largest plans. See footnote 9 in  main text for further explanation.  (Dollar figures in millions of 2002 dollars)
Plans drawing down accumulated credit balance  Accumulated credit balance from prior years  Median figures reported are the average of individual year median values.
For analysis, each year contains that year’s 100 largest plans, ranked by current liabilities. From 1995  to 2002, 187 unique plans appear in at least 1 year’s sample of 100 largest plans. See footnote 9 in  main text for further explanation.  (Dollar figures in millions of 2002 dollars)
Plans with FFL = 0  Sponsors contributing at least as much as FFL  Instances in which plan making contribution at least  equal to FFL used highest allowable interest rate  Median figures reported are the average of individual year median values.
For analysis, each year contains that year’s 100 largest plans, ranked by current liabilities. From 1995  to 2002, 187 unique plans appear in at least 1 year’s sample of 100 largest plans. See footnote 9 in  main text for further explanation.
Dollar figures in millions of 2002 dollars  Current liabilities of plans subject to AFC  Funding gap of plan assessed an AFC  Funded percentage of plan subject to AFC  Plans below 90% funded subject to AFC  Plans 80 to 90% funded subject to AFC  Cash contribution, plans subject to AFC  Plans subject to AFC forgoing cash contribution  Plans subject to AFC drawing down credit balance  Median figures reported are the average of individual year median values.
For analysis, each year contains that year’s 100 largest plans, ranked by current liabilities. From 1995  to 2002, 187 unique plans appear in at least 1 year’s sample of 100 largest plans. See footnote 9 in  main text for further explanation.
section_title: Appendix III: Comments from the Department of Labor
section_title: Appendix IV: Comments from the Pension Benefit Guaranty Corporation
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: Contact
paragraphs: Barbara Bovbjerg (202) 512-7215.
section_title: Staff Acknowledgments
paragraphs: In addition to the contact above, Charles A. Jeszeck, Charles J. Ford,  Joseph Applebaum, Mark M. Glickman, Scott Heacock, Roger J. Thomas,  and Amy Vassalotti made important contributions to this report.
section_title: Glossary
paragraphs: Actuarial value of assets—the smoothed value of DB plan assets,  reflecting recent market levels of assets. Rules dictate that the reported  actuarial assets must be between 80 and 120 percent of market asset levels  and cannot be consistently above or below market values.
Additional funding charge (AFC)—a surcharge assessed to DB plans  that fail specific funding level requirements that increases the minimum  required funding obligation for the plan sponsor.
Credit balance—the excess of credits over charges in a plan’s funding  standard account, which can be carried forward to meet funding  obligations in future years.
Current liabilities—the measured value of a DB plan’s accrued benefits  using an interest rate and other assumptions specified in applicable laws  and regulations.
Defined benefit (DB) pension plan—a pension plan that promises a  guaranteed benefit, generally based on an employee’s salary and years of  service. (A different type of pension plan, a defined contribution, or DC,  plan, instead provides an individual account to an employee, to which  employers, employees, or both make periodic contributions.)
Employee Retirement Income Security Act of 1974 (ERISA)—the  federal law that sets minimum standards regarding management,  operation, and funding of pension plans sponsored by private employers.
Full funding limitation (FFL)—a limit on the required amount a  sponsor must contribute to a plan each year, dependent on the plan’s  funding level.
Funded ratio—the ratio of plan assets to plan liabilities.
Funding standard account (FSA)—a plan’s annual accounting record,  recording events that reflect an increase in a plan’s obligations (charges)  and those that reflect an increase in the plan’s ability to pay benefits  (credits).
Maximum deductible contribution—the maximum a sponsor can  generally contribute to a plan without facing an excise tax on the excess  contribution.
Normal cost—the cost of pension benefits allocated to a specific plan  year.
Termination liabilities—the measured value of a DB plan’s accrued  benefits, using assumptions appropriate for a terminating plan.
section_title: Related GAO Products
paragraphs: Pension Benefit Guaranty Corporation Structural Problems Limit  Agency's Ability to Protect Itself from Risk, GAO-05-360T. Washington,  D.C.: March 2, 2005.
Private Pensions: Airline Plans’ Underfunding Illustrates Broader  Problems with the Defined Benefit Pension System. GAO-05-108T.  Washington, D.C.: October 7, 2004.
Pension Plans: Additional Transparency and Other Actions Needed in  Connection with Proxy Voting. GAO-04-749. Washington, D.C.: August 10,  2004.
Private Pensions: Publicly Available Reports Provide Useful but Limited  Information on Plans’ Financial Condition. GAO-04-395. Washington,  D.C.: March 31, 2004.
Private Pensions: Timely and Accurate Information Is Needed to  Identify and Track Frozen Defined Benefit Plans. GAO-04-200R.  Washington, D.C.: December 17, 2003.
Pension Benefit Guaranty Corporation: Single-Employer Pension  Insurance Program Faces Significant Long-Term Risks. GAO-04-90.  Washington, D.C.: October 29, 2003.
Private Pensions: Changing Funding Rules and Enhancing Incentives  Can Improve Plan Funding. GAO-04-176T. Washington, D.C.: October 29,  2003.
Pension Benefit Guaranty Corporation: Long-Term Financing Risks to  Single-Employer Insurance Program Highlight Need for Comprehensive  Reform. GAO-04-150T. Washington, D.C.: October 14, 2003.
Pension Benefit Guaranty Corporation: Single-Employer Pension  Insurance Program Faces Significant Long-Term Risks. GAO-03-873T.  Washington, D.C.: September 4, 2003.
Options to Encourage the Preservation of Pension and Retirement  Savings: Phase 2. GAO-03-990SP. Washington, D.C.: July 29, 2003.
Private Pensions: Participants Need Information on Risks They Face in  Managing Pension Assets at and during Retirement. GAO-03-810.  Washington, D.C.: July 29, 2003.
Private Pensions: Process Needed to Monitor the Mandated Interest Rate  for Pension Calculations. GAO-03-313. Washington, D.C.: February 27,  2003.
Answers to Key Questions About Private Pension Plans. GAO-02-745SP.   Washington, D.C.: September 18, 2002.