Private Pensions: Changing Funding Rules and Enhancing Incentives Can Improve Plan Funding
Published: 2003-10-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Over the last few years, the total underfunding in the defined-benefit pension system has deteriorated to the point where the Pension Benefit Guaranty Corporation (PBGC), the federal agency responsible for protecting private sector defined benefit plan benefits, estimates that total plan underfunding grew to more than $400 billion as of December 31, 2002, and still exceeded $350 billion as of September 4, 2003. PBGC itself faced an estimated $8.8 billion accumulated deficit as of August 31, 2003. Deficiencies in current funding and related regulations have contributed to several large plans recently terminating with severely underfunded pension plans. This testimony provides GAO's observations on a variety of regulatory and legislative reforms that aim to improve plan funding and better protect the benefits of millions of American workers and retirees while minimizing the burden to plan sponsors of maintaining defined-benefit plans.
section_title: What GAO Found
paragraphs: Recent terminations of severely underfunded pension plans suggest that current funding rules do not provide adequate mechanisms for maintaining adequate funding of pension plans. Funding inadequacies place the retirement security of millions of American workers and retirees, along with PBGC, at risk. While external factors, such as falling stock prices, low interest rates, and slow economic growth, have contributed to widespread pension underfunding, the defined-benefit system also faces structural problems that extend beyond cyclical economic conditions. Stagnant growth of the defined-benefit system, along with several large recent terminations of underfunded pension plans, has left PBGC in a precarious financial condition as the insurer of pension benefits. There are two general approaches to funding reform that may improve the funding of defined-benefit pension plans. The first approach would change the funding requirements directly. These measures could address reforms to the use of termination liability instead of current liability, additional funding requirements, and lump-sum distributions. The second, more indirect approach would seek to improve plan funding by providing better incentives for sponsors to keep their plans better funded. Options in this category could include requirements broadening the disclosure of plan investments and termination liability information to plan participants and their representatives. These reforms, as part of a comprehensive package, could increase the likelihood that workers and retirees receive promised benefits, while not creating an undue regulatory or financial burden on sponsors. Recent unfavorable economic conditions have contributed to widespread underfunding and conspired to place well-meaning plan sponsors in difficult positions. Although comprehensive reform should include improving plan funding as the key vehicle to stabilize the long-term health of the defined-benefit system, Congress may seek to balance improvements in funding and accountability against the short-term needs of some sponsors who may have difficulty making plan contributions.

section_title: Letter
paragraphs: I am pleased to be here today to discuss improving the funding of single- employer defined-benefit plans. As all of you are aware, this is a crucial  issue threatening the retirement security of millions of America’s workers  and retirees. Underfunded plans sponsored by weak or bankrupt  employers have drained the financial resources of the Pension Benefit  Guaranty Corporation (PBGC), the backstop federal agency that insures  the benefits promised by these plan. PBGC’s single-employer insurance  program currently faces an estimated deficit of $8.8 billion as of August 31,  2003, following the largest 1-year loss in the agency’s history. This deficit  could likely increase during the next few years, with PBGC estimating that  by the end of fiscal year 2003, total underfunding in financially troubled  firms could exceed $80 billion. We believe that an appropriate  comprehensive policy response can stabilize the funding of these pension  plans, thereby protecting workers’ benefits for the foreseeable future.  Reforming the rules that regulate how sponsors fund their pension plans is  an essential part of this response. I hope my testimony will help clarify  some of the key issues as the Congress and the relevant agencies choose  how to respond to these serious financial challenges. As you requested, I  will discuss some options to improve the funding status of defined-benefit  plans.
To identify the types of reform that may improve funding for defined- benefit (DB) pension plans, we reviewed proposals for reforming the  single-employer program made by the Department of the Treasury, PBGC,  and pension professionals. We also discussed with PBGC officials, and  examined annual reports and other available information related to the  funding and termination of three pension plans: the Anchor Glass  Container Corporation Service Retirement Plan, the Pension Plan of  Bethlehem Steel Corporation and Subsidiary Companies, and the Polaroid  Pension Plan. We selected these plans because they represented the  largest losses to PBGC in their respective industries in fiscal year 2002.  PBGC estimates that, collectively, the plans represented over $4 billion in  losses to the program at plan termination. At the request of this  committee, we will release a report at the end of this month on the  financial condition of the PBGC single-employer pension program and  related issues of pension plan reform.
To summarize my responses, there are two general approaches to funding  reform that may improve the funding of defined-benefit pension plans. The  first approach would change the funding requirements directly. These  measures could encompass reforms to the use of current and termination  liability in plan funding calculations, additional funding requirements,  credit balances, unfunded benefits or benefit increases, and lump-sum  distributions. The second, more indirect approach would seek to improve  plan funding by providing better incentives for sponsors to keep their  plans better funded. Options in this category could include requirements  broadening the disclosure of plan investments and termination liability  information to plan participants and their representatives, the  restructuring of PBGC’s variable-rate premium to incorporate risk factors  other than the level of underfunding, and making modifications to certain  guaranteed benefits that could decrease losses incurred from underfunded  plans. Reforms adopted to directly change the funding requirements or  improve plan funding through providing incentives for sponsors are not  mutually exclusive, and several variations exist within each reform option.  These reforms, taken separately or in coordination, could increase the  likelihood of plans receiving adequate funding to ensure that workers and  retirees receive promised benefits.
subsections: section_title: Background
paragraphs: Before enactment of the Employee Retirement and Income Security Act  (ERISA) of 1974, few rules governed the funding of defined-benefit  pension plans, and participants had no guarantees that they would receive  the benefits promised. When Studebaker’s pension plan failed in the 1960s,  for example, many plan participants lost their pensions. Such experiences  prompted the passage of ERISA to better protect the retirement savings of  Americans covered by private pension plans. Along with other changes,  ERISA established PBGC to pay the pension benefits of participants,  subject to certain limits, in the event that an employer could not. ERISA  also required PBGC to encourage the continuation and maintenance of  voluntary private pension plans and to maintain premiums set by the  corporation at the lowest level consistent with carrying out its  obligations.
Under ERISA, the termination of a single-employer defined-benefit plan  results in an insurance claim with the single-employer program if the plan  has insufficient assets to pay all benefits accrued under the plan up to the  date of plan termination. PBGC finances the unfunded liabilities of  terminated plans partially through premiums paid by plan sponsors.  Currently, plan sponsors pay a flat-rate premium of $19 per participant per  year; in addition, some pay a variable-rate premium, which was added in  1987 to provide an incentive for sponsors to better fund their plans. The  variable-rate premium, which started at $6 for each $1,000 of unfunded  vested benefits, was initially capped at $34 per participant. The variable  rate was increased to $9 for each $1,000 of unfunded vested benefits  starting in 1991, and the cap on variable-rate premiums was removed  starting in 1996.
Following the enactment of ERISA, however, concerns were raised about  the potential losses that PBGC might face from the termination of  underfunded plans. To protect PBGC, ERISA was amended in 1986 to  require that plan sponsors meet certain additional conditions before  terminating an underfunded plan. For example, sponsors could voluntarily  terminate their underfunded plans only if they were bankrupt or generally  unable to pay their debts without the termination.
The single-employer program has had an accumulated deficit—that is,  program assets have been less than the present value of benefits and other  liabilities—for much of its existence. (See fig. 1.) In fiscal year 1996, the  program had its first accumulated surplus, and by fiscal year 2000, the  accumulated surplus had increased to about $10 billion, in 2002 dollars.  However, the program’s finances reversed direction in 2001, and at the end  of fiscal year 2002, its accumulated deficit was about $3.6 billion. PBGC  estimates that this deficit grew to $8.8 billion by August 31, 2003, its largest  deficit in the program’s history both in real and nominal terms. From less  than $50 billion as of December 31, 2000, the total underfunding in single- employer plans grew to more than $400 billion as of December 31, 2002,  and still exceeds $350 billion according to recent estimates by PBGC. (See  fig 2.) Despite the program’s large deficit, according to a PBGC analysis,  the single-employer program was estimated to have enough assets to pay  benefits through 2019, given the program’s conditions and PBGC  assumptions as of the end of fiscal year 2002. However, losses since that  time may have shortened the period over which the program will be able  to cover promised benefits. In July of this year, because of serious risks to  the single-employer program’s viability, we placed the PBGC on our high- risk list.
For the most part, liabilities of the single-employer pension insurance  program are comprised of the present value of insured participant  benefits. PBGC calculates present values using interest rate factors that,  along with a specified mortality table, reflect annuity prices, net of  administrative expenses, obtained from surveys of insurance companies  conducted by the American Council of Life Insurers. In addition to the  estimated total liabilities of underfunded plans that have actually  terminated, PBGC includes in program liabilities the estimated unfunded  liabilities of underfunded plans that it believes will probably terminate in  the near future. PBGC may classify an underfunded plan as a probable  termination when, among other things, the plan’s sponsor is in liquidation  under federal or state bankruptcy laws.
subsections: section_title: Several Factors Have Contributed to PBGC’s Current Financial Difficulties
paragraphs: As we reported to this committee in September of this year, several  factors have contributed to PBGC’s and plans’ current financial  difficulties. The financial condition of the single-employer pension  insurance program returned to an accumulated deficit in 2002 largely due  to the termination, or expected termination, of several severely  underfunded pension plans. In 1992, we reported that many factors  contributed to the degree plans were underfunded at termination,  including the payment at termination of additional benefits, such as  subsidized early retirement benefits, which have been promised to plan  participants if plants or companies ceased operations. These factors  likely contributed to the degree that plans terminated in 2002 were  underfunded. Factors that increased the severity of the plans’ unfunded  liability in 2002 were the recent sharp decline in the stock market and a  general decline in interest rates.
In many cases, sponsors did not make the contributions necessary to  adequately fund the plans before they were terminated. For example,  according to annual reports (Annual Return/Report of Employee Benefit  Plan, Form 5500) submitted by Bethlehem Steel Corporation, in the 7 years  from 1992 to 1999, the Bethlehem Steel pension plan went from 86 percent  funded to 97 percent funded. (See fig. 3.) From 1999 to plan termination in  December 2002, however, plan funding fell to 45 percent as assets  decreased and liabilities increased, and sponsor contributions were not  sufficient to offset the changes. According to a survey, the Bethlehem  Steel defined-benefit plan had about 73 percent of its assets (about $4.3  billion of $6.1 billion) invested in domestic and foreign stocks on  September 30, 2000. One year later, assets had decreased $1.5 billion, or  25 percent, and when the plan was terminated in December 2002, its assets  had been reduced another 23 percent to about $3.5 billion—far less than  needed to finance an estimated $7.2 billion in PBGC-guaranteed  liabilities. Surveys of plan investments by Greenwich Associates  indicated that defined-benefit plans in general had about 62.8 percent of  their assets invested in U.S. and international stocks in 1999.
These recent events and their consequences for PBGC’s finances have  occurred in the context of the long-term stagnation of the defined-benefit  system. The number of PBGC-insured plans has decreased steadily from  approximately 110,000 in 1987 to around 30,000 in 2002. While the  number of total participants in PBGC-insured single-employer plans has  grown approximately 25 percent since 1980, participation has declined as  a percentage of the private sector labor force. Further, the percentage of  participants who are active workers has declined from 78 percent in 1980  to 53 percent in 2000. Manufacturing, a sector with virtually no job growth  in the last half-century, accounted for almost half of PBGC’s single- employer program participants in 2001, suggesting that the program needs  to rely on other sectors for any growth in premium income. Unless  something reverses these trends, PBGC may have a shrinking plan and  participant base to support the program in the future as well as the  likelihood of a participant base concentrated in certain, potentially more  vulnerable industries.
section_title: Minimum Funding Rules Did Not Prevent Plans from Being Severely Underfunded
paragraphs: Internal Revenue Code (IRC) minimum funding rules, which are designed  to ensure plan sponsors adequately fund their plans, did not have the  desired effect for the terminated plans that were added to the single- employer program in 2002. The amount of contributions required under  IRC minimum funding rules is generally the amount needed to fund  benefits earned during that year plus that year’s portion of other liabilities  that are amortized over a period of years. Also, the rules require the  sponsor to make an additional contribution if the plan is underfunded to  the extent defined in the law. Under the additional funding requirement  rule, a single-employer plan sponsored by an employer with more than  100 employees in defined-benefit plans is subject to a deficit reduction  contribution for a plan year if the value of plan assets is less than  90 percent of its current liability. However, a plan is not subject to the  deficit reduction contribution if the value of plan assets (1) is at least  80 percent of current liability and (2) was at least 90 percent of current  liability for each of the 2 immediately preceding years or each of the  second and third immediately preceding years. To determine whether the  additional funding rule applies to a plan, the IRC requires sponsors to  calculate current liability using the highest interest rate allowable for the  plan year.
In 1987, the minimum funding rules incorporated by ERISA in the IRC  were amended to require that plan sponsors calculate each plan’s current  liability, using a discount rate based on the 30-year Treasury bond rate,  and to use that calculation to assess the plan’s funding level. If plans are  funded below certain thresholds as defined in the IRC, employers are to  determine minimum contribution amounts on the basis of those  assessments. Employers must make additional contributions to the plan if  it is underfunded to extent defined in the law. If a plan is fully funded as  defined in the law, employers are precluded from making additional tax- deductible contributions to the plan. In 2002, the Congress acted to  provide temporary relief to DB plan sponsors by raising the top of the  permissible range of the mandatory interest rate. As discussed in a report  we issued earlier this year, concerns that the 30-year Treasury bond rate  no longer resulted in reasonable current liability calculations has led both  Congress and the administration to propose alternative rates for these  calculations.
While minimum-funding rules may encourage sponsors to better fund their  plans, plans can earn funding credits, which can be used to offset  minimum funding contributions in later years, by contributing more than  required according to minimum funding rules. Therefore, sponsors of  underfunded plans may avoid or reduce minimum funding contributions to  the extent their plan has a credit balance in the account, referred to as the  funding standard account, used by plans to track minimum funding  contributions.
Additionally, the rules require sponsors to assess plan funding using  current liabilities, which a PBGC analysis indicates have been typically  less than termination liabilities. A plan’s termination liability measures  the value of accrued benefits using assumptions appropriate for a  terminating plan, while its current liability measures the value of accrued  benefits using assumptions specified in applicable laws and regulations.  Current and termination liabilities differ because the assumptions used to  calculate them differ. Interest rates are a key assumption in calculating the  present value of future pension benefits: while all sponsors calculate  current liabilities using a rate based on the 30-year Treasury bond rate,  ERISA requires sponsors of some underfunded plans to report plan  termination liability information to PBGC. These sponsors calculate  termination liability using a rate published by PBGC, based on surveys of  insurance companies performed by the American Council of Life  Insurers.
Other aspects of minimum funding rules may limit their ability to affect the  funding of certain plans as their sponsors approach bankruptcy. According  to its annual reports, for example, Bethlehem Steel contributed about $3.0  billion to its pension plan for plan years 1986 through 1996. According to  the reports, the plan had a credit balance of over $800 million at the end of  plan year 1996. Starting in 1997, Bethlehem Steel reduced its contributions  to the plan and, according to annual reports, contributed only about $71.3  million for plan years 1997 through 2001. The plan’s 2001 actuarial report  indicates that Bethlehem Steel’s minimum required contribution for the  plan year ending December 31, 2001, would have been $270 million in the  absence of a credit balance; however, the opening credit balance in the  plan’s funding standard account as of January 1, 2001, was $711 million.  Therefore, Bethlehem Steel was not required to make any contributions  during the year.
Other IRC funding rules may have prevented some sponsors from making  contributions to plans that in 2002 were terminated at a loss to the single- employer program. For example, on January 1, 2000, the Polaroid pension  plan’s assets were about $1.3 billion compared to accrued liabilities of  about $1.1 billion—the plan was more than 100 percent funded. The plan’s  actuarial report for that year indicates that the plan sponsor was  precluded by IRC funding rules from making a tax-deductible contribution  to the plan. In July 2002, PBGC terminated the Polaroid pension plan, and  the single-employer program assumed responsibility for $321.8 million in  unfunded PBGC-guaranteed liabilities for the plan. The plan was about 67  percent funded, with assets of about $657 million to pay estimated PBGC- guaranteed liabilities of about $979 million.
section_title: Strengthening Plan Funding Rules Can Help Sponsors Maintain Well-Funded Plans
paragraphs: Several types of reforms might be considered to improve the funding of  defined-benefit pension plans. Some options for reform would directly  address funding requirements and related rules. Funding rules could be  revised to require increased minimum contributions to underfunded plans  and to allow additional contributions to fully funded plans. This approach  would improve plan funding over time and improve the security of  workers’ benefits, while limiting the losses PBGC would incur when a plan  is terminated. Such a change would require some sponsors to allocate  additional resources to their pension plans, which may cause the plan  sponsor of an underfunded plan to provide less generous wages or  benefits than would otherwise be provided. Also, such funding rule  changes could take years to have a meaningful effect on PBGC’s financial  condition. As examples of such funding rule revisions, the IRC could be  amended to:
Base Additional Funding Requirement and Maximum Tax- Deductible Contributions on Plan Termination Liabilities, Rather  than Current Liabilities. Since plan termination liabilities typically  exceed current liabilities, such a change regarding deficit reduction  contributions would likely improve plan funding and, therefore, reduce  potential claims against PBGC. One potential problem with this approach  is the difficulty plan sponsors would have in determining the appropriate  interest rate to use in valuing termination liabilities. As we reported,  selecting an appropriate interest rate for termination liability calculations  is difficult because little information exists on which to base the  selection.
Change Requirements For Making Additional Funding  Contributions. IRC requires sponsors to make additional contributions  under two circumstances: (1) if the value of plan assets is less than 80  percent of its current liability or (2) if the value of plan assets is less than  90 percent of its current liability, depending on plan funding levels for the  previous 3 years. Raising the threshold would require more sponsors of  underfunded plans to make the additional contributions.
Limit the Use of Credit Balances by Severely Underfunded Plans to  Avoid Additional Contributions. For sponsors who make contributions  in any given year that exceed the minimum required contribution, the  excess plus interest is credited against future required contributions.  Limiting the use of credit balances to offset contribution requirements  might also prevent sponsors of significantly underfunded plans from  avoiding cash contributions. For example, in the absence of a credit  balance, Bethlehem Steel would have been due to pay at least $270 million  to its pension plan for the plan year ending December 31, 2001; however,  because it showed a credit balance of $711 million as of January 1, 2001,  Bethlehem was not required to make any cash contributions for that year.  Limitations might also be applied based on the plan sponsor’s financial  condition. For example, sponsors with poor cash flow or low credit ratings  could be restricted from using their credit balances to reduce their  contributions.
Limit Lump-Sum Distributions by Plans That Are Significantly  Underfunded. Defined-benefit pension plans may offer participants the  option of receiving their benefit in a lump-sum payment. Allowing  participants to take lump-sum distributions from severely underfunded  plans, especially those sponsored by financially weak companies, allows  the first participants who request a distribution to drain plan assets, which  might result in the remaining participants receiving reduced payments  from PBGC if the plan terminates. A “tiered system” may be set up  whereby a plan that does not meet a certain funding ratio threshold might  be prohibited from allowing highly compensated employees from taking  benefits as lump sums; below a lower funding ratio threshold, lump-sum  withdrawals for all employees might be prohibited. However, the payment  of lump sums by underfunded plans may not directly increase losses to the  single employer program because lump sums reduce plan liabilities as well  as plan assets.
Raise the Level of Tax-Deductible Contributions. IRC and ERISA  restrict tax-deductible contributions to prevent plan sponsors from  contributing more to their plan than is necessary to cover accrued future  benefits. This can prevent employers from making plan contributions  during periods of strong profitability. Raising these limitations might result  in pension plans being better funded, decreasing the likelihood that they  will be underfunded should they terminate.
Expand Restrictions on Unfunded Benefit Increases. Currently, plan  sponsors must meet certain conditions before increasing the benefits of  plans that are less than 60 percent funded. Increasing this threshold, or  restricting benefit increases or accruals when plans reach the threshold,  could decrease the losses incurred by PBGC from underfunded plans. One  disadvantage is that it could result in lower pension benefits for affected  workers. In addition, plan sponsors have said that the disadvantage of  such changes is that they would limit an employer’s flexibility with regard  to setting compensation, making it more difficult to respond to labor  market developments. For example, a plan sponsor might prefer to offer  participants increased pension payments or shutdown benefits instead of  offering increased wages because pension benefits can be deferred—  providing time for the plan sponsor to improve its financial condition—  while wage increases have an immediate effect on the plan sponsor’s  financial condition.
Improve Funding of Shutdown Benefits. Shutdown benefits provide  significant early retirement benefit subsidies or other benefits offered to  participants affected by a plant closing or a permanent layoff. Such  benefits are primarily found in the pension plans of large unionized  companies in the auto, steel, and tire industries. In general, shutdown  benefits cannot be adequately funded before a shutdown occurs. Rules  could mandate accelerated funding of shutdown benefits after they go into  effect. However, if a plant shutdown coincides with the bankruptcy of a  company and the termination of the pension plan, it may be impossible for  the bankrupt sponsor to fund these benefits.
In addition to funding rules, plan sponsors need an accurate funding  “target” that provides enough funding to pay promised current and future  benefits while not leading sponsors to “overfund” their pension plans,  siphoning resources from other productive firm specific activities. The  interest rate sponsors use to determine plan liabilities can affect this target  and, therefore, plan funding. In 1987, when the 30-year Treasury bond rate  was adopted for use in certain pension calculations, the Congress intended  that the interest rate used for current liability calculations would, within  certain parameters, reflect the price an insurance company would charge  to take responsibility for the plan’s pension payments. However, selecting  a replacement rate that will provide an accurate funding target may be  difficult because little information exists on which to base the selection. In taking action to replace the 30-year Treasury bond rate, it is important  to consider the impact that any change may have on funding. If Congress  mandates the use of a rate that is “too high,” plans are more likely to  appear better funded, but minimum and maximum employer contributions  would decrease, possibly increasing the likelihood of plan underfunding.  In addition, some plans would reach full-funding limitations and avoid  having to pay variable-rate premiums, and PBGC would receive less  revenue. Conversely, a rate that is “too low” would make plans appear  worse funded, with more plans likely to increase contributions and  possibly pay variable-rate premiums. Thus, it may well be prudent for  Congress to make any provision replacing the 30-year Treasury bond rate  temporary to facilitate more comprehensive funding reform to take shape.
section_title: Other Reforms Might Enhance Sponsor Incentives to Maintain Plan Funding
paragraphs: In addition to direct changes to the funding rules, other reforms may result  in improved plan funding by improving incentives for sponsors to maintain  proper funding in their plans. These measures may prevent plans from  terminating with severely underfunded balances, thus better protecting  workers, retirees, and PBGC. For example, improving the availability of  information to plan participants and others about plan investments,  termination funding status, and PBGC guarantees may give plan sponsors  additional incentives to better fund their plans, making participants better  able to plan for their retirement. The restructuring of PBGC’s premium  rates could also provide an incentive for plan sponsors to better fund their  plans. It is also possible that basing changes to premium rates on the  degree of risk posed by different plans may encourage financially healthy  companies to remain in or enter the defined-benefit system while  discouraging riskier plan sponsors. Moreover, it may be appropriate to  consider modifying certain benefit guarantees that could decrease losses  incurred by PBGC from underfunded plans. ERISA could be amended to:
Require Greater Disclosure of Information on Plan Investments.
Some information on the allocation of plan investments among asset  classes—such as equity or fixed income—may be available from Form  5500s prepared by plan sponsors, but that information is not readily  accessible to participants and beneficiaries. Additionally, some plan  investments may be made through common and collective trusts, master  trusts, and registered investment companies, and asset allocation  information for these investments might need to be obtained from Form  5500s prepared by those entities or from their prospectuses. As such,  improving the availability of plan asset allocation information to  participants may give plan sponsors an incentive to increase funding of  underfunded plans or limit riskier investments. Moreover, only  participants in plans below a certain funding threshold receive annual  notices regarding the funding status of their plans, and the information  plans must currently provide does not reflect how the plan’s assets are  invested. One way to enhance notices provided to participants could be to  include information on how much of plan assets are invested in the  sponsor’s own securities. This would be of concern because should the  sponsor become bankrupt, the value of the securities could be expected to  drop significantly, reducing plan funding. Although this information is  currently provided in the plan’s Form 5500, it is not readily accessible to  participants. Additionally, if the defined-benefit plan has a floor-offset  arrangement and its benefits are contingent on the investment  performance of a defined-contribution plan, then information provided to  participants could also disclose how much of that defined-contribution  plan’s assets are invested in the sponsor’s own securities.
Require Greater Disclosure of Plan Termination Funding Status.
Under current law, sponsors are required to report a plan’s current liability  for funding purposes, which often can be lower than termination liability.
In addition, only participants in plans below a certain funding threshold  receive annual notices of the funding status of their plans. As a result,  many plan participants, including participants of the Bethlehem Steel  pension plan, did not receive such notifications in the years immediately  preceding the termination of their plans. Expanding the circumstances  under which sponsors must notify participants of plan underfunding might  give sponsors an additional incentive to increase plan funding and would  enable more participants to better plan their retirement. Under the  Administration’s proposal, all sponsors would be required to disclose the  value of pension plan assets on a termination basis in their annual  reporting. The Administration proposes that all companies disclose the  value of their defined-benefit pension plan assets and liabilities on both a  current liability and termination liability basis in their Summary Annual  Report (SAR).
Increase or Restructure Variable-Rate Premium. PBGC charges plan  sponsors a variable-rate premium based on the plan’s level of  underfunding, premiums, with sponsors paying $9 per $1,000 of unfunded  liability. However, the recent terminations of Bethlehem Steel, Anchor  Glass, and Polaroid, plans that paid no variable-rate premiums shortly  before terminating with large underfunded balances, suggest that the  current structure of the variable-rate premium does not provide a strong  enough incentive to improve plan funding or is too easily avoidable. The  rate could be adjusted so that plans with less adequate funding pay a  higher rate. In addition, premium rates could be restructured based on the  degree of risk posed by different plans, which could be assessed by  considering the financial strength and prospects of the plan’s sponsor, the  risk of the plan’s investment portfolio, participant demographics, and the  plan’s benefit structure—including plans that have lump-sum, shutdown  benefit, and floor-offset provisions. One advantage of a rate increase or  restructuring is that it might improve accountability by providing for a  more direct relationship between the amount of premium paid and the risk  of underfunding. A disadvantage is that it could further burden already  struggling plan sponsors at a time when they can least afford it, or it could  reduce plan assets, increasing the likelihood that underfunded plans will  terminate. A program with premiums that are more risk-based could also  be more challenging for PBGC to administer.
Phase-in the Guarantee of Shutdown Benefits. PBGC is concerned  about its exposure to the level of shutdown benefits, or benefit increases  that are unfunded at termination. PBGC could phase-in the guarantee of  such benefits. Similar to benefit increases prior to termination, the agency  could perhaps guarantee an additional 20 percent of shutdown benefits  each year after the benefits are offered, with full benefits (up to PBGC  limits) guaranteed only after 5 years. Phasing in guarantees from the date  of the applicable shutdown could decrease the losses incurred by PBGC  from underfunded plans. A phase-in might cause workers to put pressure  on sponsors to fund these benefits or benefit increases, or demand  alternative forms of compensation. Modifying these benefits would reduce  the early retirement benefits for participants who are in plans with such  provisions and are affected by a plant closing or a permanent layoff.  Dislocated workers, particularly in manufacturing, may suffer additional  losses from lengthy periods of unemployment or from finding  reemployment only at much lower wages.
section_title: Conclusion
paragraphs: Widespread underfunding in the defined-benefit pension system  potentially threatens the retirement security of millions of American  workers. The termination of severely underfunded plans can significantly  reduce the benefits promised to workers and retirees. It also threatens the  solvency of PBGC’s single-employer insurance program, with, in the worse  case, Congress facing the choice of a bailout or of letting affected workers  and retirees lose the pension benefits they depend on. While the pension  system does not face an immediate crisis, these serious financial  challenges suggest that meaningful, if perhaps difficult, comprehensive  action needs to be taken. Such action would be aimed towards the  improvement of the long-term funding status of plans and the  accountability of plan sponsors, especially those that represent a clear risk  to PBGC, plan participants, and their beneficiaries.
Undoubtedly, unfavorable economic conditions have contributed to  widespread underfunding and conspired to place well-meaning sponsors  in very difficult positions to maintain their plans’ funding. Although  comprehensive reform should include improving plan funding as the key  vehicle to stabilize and enhance the long-term health of the defined-benefit  system, Congress may seek to balance improvements in funding and  accountability against the short-term needs of some sponsors who may  have difficulty making contributions to their plans. Relief measures should  be carefully targeted to those sponsors that may need it most urgently,  with some provision for this aid to eventually lead to improved plan  funding. In crafting this reform, the Congress should be wary of temporary  rule changes directed exclusively to short-term problems that could  increase the risk that plans terminate in even worse financial straits than  they suffer today.
It is important to keep in mind that the factors contributing to the  deterioration of pension plan funding go beyond the effects of the recent  economic downturn. The defined-benefit system has shown signs of  stagnation for the past 2 decades, with a steady decline in the number of  plans and a decreasing proportion of working participants. PBGC’s  participant base may also be concentrated in more vulnerable industries.  Concerns about PBGC’s long-run financial viability, and not just the recent  alarming jump in its accumulated deficit, prompted us to put the single- employer program on our high-risk list. While it is unlikely that any rules  can guarantee that all plans are fully funded at all times, nor should that be  their goal, regulations should strive to maintain the overall health of the  system and prevent poor economic conditions from creating a general  funding crisis.
In addition to the administration’s current proposal, the Treasury  Department, Labor Department, and PBGC are considering reforms that  seek to address many of these issues and include elements of the options  that I have identified in my testimony, such as increased transparency for  plan participants. The private defined-benefit pension system is at a  crossroads, facing a threat of continued financial erosion and decline.  However, we also have the opportunity and the challenge to broadly move  the system back to a solid, stable financial footing that will provide needed  retirement benefits to workers and retirees for decades to come.
Mr. Chairman, this concludes my statement. I would be happy to respond  to any questions that you or other members of the Committee may have.
For information regarding this testimony, please contact Barbara D.  Bovbjerg, Director, Education, Workforce, and Income Security Issues, on  (202) 512-7215 or Charles A. Jeszeck on (202) 512-7036. Individuals who  made key contributions to this testimony are Mark M. Glickman,  Jeremy Citro, Daniel F. Alspaugh, and John M. Schaefer.
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