Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance Program Faces Significant Long-Term Risks
Published: 2003-10-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: More than 34 million participants in 30,000 single-employer defined benefit pension plans rely on a federal insurance program managed by the Pension Benefit Guaranty Corporation (PBGC) to protect their pension benefits, and the program's long-term financial viability is in doubt. Over the last decade, the program swung from a $3.6 billion accumulated deficit (liabilities exceeded assets), to a $10.1 billion accumulated surplus, and back to a $3.6 billion accumulated deficit, in 2002 dollars. Furthermore, despite a record $9 billion in estimated losses to the program in 2002, additional severe losses may be on the horizon. PBGC estimates that financially weak companies sponsor plans with $35 billion in unfunded benefits, which ultimately might become losses to the program.
section_title: What GAO Found
paragraphs: 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. Factors that contributed to the severity of the plans' underfunded condition included a sharp stock market decline, which reduced plan assets, and an interest rate decline, which increased plan termination costs. For example, PBGC estimates losses to the program from terminating the Bethlehem Steel pension plan, which was nearly fully funded in 1999 based on reports to the Internal Revenue Service (IRS), at $3.7 billion when it was terminated in 2002. The plan's assets had decreased by over $2.5 billion, while its liabilities had increased by about $1.4 billion since 1999. The single-employer program faces two primary risks to its long-term financial viability. First, the large losses in 2002 could continue or accelerate if, for example, structural problems in particular industries result in additional bankruptcies. Second, revenue from premiums and investments might be inadequate to offset program losses. Participant-based premium revenue might fall, for example, if the number of program participants decreases. Because of these risks, GAO has recently placed the single-employer insurance program on its high-risk list of agencies with significant vulnerabilities to the federal government. While the recent decline in the single-employer program's financial condition is not an immediate crisis, the threats to the program's long-term viability should be addressed. Several reforms might be considered to reduce the risks to the program's long-term financial viability. These include strengthening funding rules applicable to poorly funded plans, modifying program guarantees, restructuring premiums, and improving the availability of information about plan investments, termination funding, and program guarantees. Under each reform, several possible actions could be taken. For example, one way to modify program guarantees is to phase-in certain unfunded benefits, such as "shutdown benefits," which may provide significant early retirement benefit subsidies to participants affected by a plant closing or a permanent layoff.

section_title: Letter
paragraphs: The Pension Benefit Guaranty Corporation’s (PBGC) single-employer  insurance program is a federal program to insure the benefits of the more  than 34 million workers and retirees participating in private defined- benefit pension plans. Over the last few years, the program’s finances  have taken a severe turn for the worse. From a $3.6 billion accumulated  deficit in 1993, the program registered a $10.1 billion accumulated surplus  (assets exceeded liabilities) in 2000 before returning to a $3.6 billion  accumulated deficit, in 2002 dollars. More fundamentally, the long-term  viability of the program is at risk. Even after assuming responsibility for  several severely underfunded pension plans and recording over $9 billion in estimated losses in 2002, PBGC estimated that as of September 30, 2002,  it faced exposure to approximately $35 billion in additional unfunded  liabilities from ongoing plans that were sponsored by financially weak  companies and may terminate.
This risk involves an issue beyond PBGC’s current and future financial  condition; it also relates to the need to protect the retirement security of  millions of American workers and retirees. This report highlights some of  the key issues in the debate about how to respond to the financial  challenges facing the federal insurance program for single-employer  defined-benefit plans. As you requested, we addressed the following  issues: (1) what factors contributed to recent changes in the single- employer pension insurance program’s financial condition, (2) what are  the risks to the program’s long-term financial viability, and (3) what  changes to the program might be considered to reduce those risks?
To identify the factors that contributed to recent changes in the single- employer program’s financial condition, we 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. To identify the primary risks to  the long-term viability of the program and options to address the  challenges facing the single-employer program, we interviewed pension  experts at PBGC, at the Employee Benefits Security Administration of the  Department of Labor, and in the private sector and reviewed analyses and  other documents provided by them. To obtain additional information as to  the risks facing PBGC from certain industries, we discussed with PBGC,  and reviewed annual and actuarial reports for the 2003 distress  termination of the U.S. Airways pension plan for pilots. To determine what  changes might be considered to reduce those risks, we reviewed proposals  for reforming the single-employer program made by the Department of the  Treasury, PBGC, and pension professionals. We performed our work from  April through September 2003 in accordance with generally accepted  government auditing standards. Our scope and methodology are explained  more fully in appendix I.
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 may pay only a portion of the claim  because ERISA places limits on the PBGC benefit guarantee. For example,  PBGC generally does not guarantee annual benefits above a certain  amount, currently about $44,000 per participant at age 65. Additionally,  benefit increases in the 5 years immediately preceding plan termination  are not fully guaranteed, though PBGC will pay a portion of these  increases. The guarantee is limited to certain benefits, including so-called  shutdown benefits—significant subsidized early retirement benefits—that  are triggered by layoffs or plant closings that occur before plan  termination. The guarantee does not generally include supplemental  benefits, such as the temporary benefits that some plans pay to  participants from the time they retire until they are eligible for Social  Security benefits.
Following 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. Key amendments to  ERISA affecting the single-employer program are listed in appendix II.
Concerns about PBGC finances also resulted in efforts to strengthen the  minimum funding rules incorporated by ERISA in the Internal Revenue  Code (IRC). In 1987, for example, the IRC was amended to require that  plan sponsors calculate each plan’s current liability, and make additional  contributions to the plan if it is underfunded to the extent defined in the  law. 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 the Congress and the administration to  propose alternative rates for these calculations.
Despite the 1987 amendments to ERISA, concerns about PBGC’s financial  condition persisted. In 1990, as part of our effort to call attention to high- risk areas in the federal government, we noted that weaknesses in the  single-employer insurance program’s financial condition threatened  PBGC’s long-term viability. We stated that minimum funding rules still  did not ensure that plan sponsors would contribute enough for terminating  plans to have sufficient assets to cover all promised benefits. In 1992, we  also reported that PBGC had weaknesses in its internal controls and  financial systems that placed the entire agency, and not just the single- employer program, at risk. Three years later, we reported that legislation  enacted in 1994 had strengthened PBGC’s program weaknesses and that  we believed improvements had been significant enough for us to remove  the agency’s high-risk designation. Since that time, we have continued to  monitor PBGC’s financial condition and internal controls. For example, in  1998, we reported that adverse economic conditions could threaten  PBGC’s financial condition despite recent improvements; in 2000, we  reported that contracting weaknesses at PBGC, if uncorrected, could  result in PBGC paying too much for required services; and this year, we  reported that weaknesses in the PBGC budgeting process limited its  control over administrative expenses.
In 1997, we reported that the cash-based federal budget, which focuses on  annual cash flows, does not adequately reflect the cost or the economic  impact of federal insurance programs, including the single-employer  pension insurance program. This is true because, generally, cost is only  recognized in the budget when claims are paid rather than when the  commitment is made. The cost of pension insurance is further obscured in  the budget because while its annual net cash flows reduce the budget  deficit, PBGC’s growing long-term commitment to pay pension benefits  has no effect on the deficit. For example, the liabilities from terminated  underfunded pension plans taken over by PBGC are not recognized in the  budget. We concluded that the use of accrual concepts in the budget for  PBGC and other insurance programs has the potential to better inform  budget choices. We also stated, however, that agencies, such as PBGC,  might need to develop and test methodologies that would enable them to  generate reasonable and unbiased cost estimates of the risk assumed by  the government, which are critical to the successful implementation of  accrual-based budgeting for insurance programs. As such, as a first step  toward developing an accrual-based budget, we recommended that the  Office of Managemetn and Budget (OMB) encourage agencies to develop  methodologies and provide cost information on a risk-assumed basis in  the budget document along side the cash-based budget information it  currently provides. OMB agreed with our conclusions and noted that they  would like to pursue such improvements but was not doing so because it  did not have the expertise that would be required.
PBGC receives no direct federal tax dollars to support the single-employer  pension insurance program. The program receives the assets of terminated  underfunded plans and any of the sponsor’s assets that PBGC recovers  during bankruptcy proceedings. PBGC finances the unfunded liabilities of  terminated plans with (1) premiums paid by plan sponsors and (2) income  earned from the investment of program assets.
Initially, plan sponsors paid only a flat-rate premium of $1 per participant  per year; however, the flat rate has been increased over the years and is  currently $19 per participant per year. To provide an incentive for  sponsors to better fund their plans, a variable-rate premium was added in  1987. 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. Figure 1 shows that, after increasing sharply in  the 1980s, flat-rate premium income declined from $753 million in 1993 to  $654 million in 2002, in constant 2002 dollars. Income from the variable- rate premium fluctuated widely over that period.
The slight decline in flat-rate premium revenue over the last decade, in real  dollars, indicates that the increase in insured participants has not been  sufficient to offset the effects of inflation over the period. Essentially,  while the number of participants has grown since 1980, growth has been  sluggish. Additionally, after increasing during the early 1980s, the number  of insured single-employer plans has decreased dramatically since  1986. (See fig. 2.)
The decline in variable-rate premiums in 2002 may be due to a number of  factors. For example, all else equal, an increase in the rate used to  determine the present value of benefits reduces the degree to which  reports indicate plans are underfunded, which reduces variable-rate  premium payments. The Job Creation and Worker Assistance Act of  2002 increased the statutory interest rate for variable-rate premium  calculations from 85 percent to 100 percent of the interest rate on 30-year  U.S. Treasury securities for plan years beginning after December 31, 2001,  and before January 1, 2004.
Investment income is also a large source of funds for the single-employer  insurance program. The law requires PBGC to invest a portion of the funds  generated by flat-rate premiums in obligations issued or guaranteed by the  United States, but gives PBGC greater flexibility in the investment of other  assets. For example, PBGC may invest funds recovered from terminated  plans and plan sponsors in equities, real estate, or other securities and  funds from variable-rate premiums in government or private fixed-income  securities. According to PBGC, however, by policy, it invests all premium  income in Treasury securities. As a result of the law and investment  policies, the majority of the single-employer program’s assets are invested  in U.S. government securities. (See fig. 3.)
Since 1990, except for 3 years, PBGC has achieved a positive return on the  investments of single-employer program assets. (See fig 4.) According to  PBGC, over the last 10 years, the total return on these investments has  averaged about 10 percent.
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.
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. 5.) In fiscal year 1996, the  program had its first accumulated surplus, and by fiscal year 2000, the  accumulated surplus had increased to almost $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  estimated that this deficit had grown to $8.8 billion by August 31, 2003.  Despite this 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. Losses since that time may have shortened the  period over which the program will be able to cover promised benefits.
section_title: Termination of Severely Underfunded Plans Was Primary Factor in Financial Decline of Single- Employer Program
paragraphs: 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. The current minimum  funding rules and variable-rate premiums were not effective at preventing  those plans from being severely underfunded at termination.
subsections: section_title: PBGC Assumed Responsibility for Several Severely Underfunded Plans in 2002
paragraphs: Total estimated losses in the single-employer program reported in PBGC  annual reports increased from $705 million in fiscal year 2001 to  $9.3 billion in fiscal year 2002. In addition to $3.0 billion in losses from the  unfunded liabilities of terminated plans, the $9.3 billion included  $6.3 billion in losses from the unfunded liabilities of plans that were  expected to terminate in the near future. Nearly all of the terminations  considered probable at the end of fiscal year 2002 have already occurred.  For example, in December 2002, PBGC involuntarily terminated an  underfunded Bethlehem Steel Corporation pension plan, which resulted in  the single-employer program assuming responsibility for about $7.2 billion  in PBGC-guaranteed liabilities, about $3.7 billion of which was not funded  at termination.
Much of the program’s losses resulted from the termination of  underfunded plans sponsored by failing steel companies. PBGC estimates  that in 2002, underfunded steel company pension plans accounted for  80 percent of the $9.3 billion in program losses for the year. The three  largest losses in the single-employer program’s history resulted from the  termination of underfunded plans sponsored by failing steel companies:  Bethlehem Steel, LTV Steel, and National Steel. All three plans were either  completed terminations or listed as probable terminations for 2002. Giant  vertically integrated steel companies, such as Bethlehem Steel, have faced  extreme economic difficulty for decades, and efforts to salvage their  defined-benefit plans have largely proved unsuccessful. According to  PBGC’s executive director, underfunded steel company pension plans  have accounted for 58 percent of PBGC single-employer losses since 1975.
section_title: Plan Unfunded Liabilities Were Increased by Stock Market and Interest Rate Declines
paragraphs: The termination of underfunded plans in 2002 occurred after a sharp  decline in the stock market had reduced plan asset values and a general  decline in interest rates had increased plan liability values, and the  sponsors did not make the contributions necessary to adequately fund the  plans before they were terminated. The combined effect of these factors  was a sharp increase in the unfunded liabilities of the terminating plans.  According to annual reports (Annual Return/Report of Employee Benefit  Plan, Form 5500) submitted by Bethlehem Steel Corporation, for example,  in the 7 years from 1992 to 1999, the Bethlehem Steel pension plan went  from 86 percent funded to 97 percent funded. (See fig. 6.) 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.
A decline in the stock market, which began in 2000, was a major cause of  the decline in plan asset values, and the associated increase in the degree  that plans were underfunded at termination. For example, while total  returns for stocks in the Standard and Poor’s 500 index (S&P 500)  exceeded 20 percent for each year from 1995 through 1999, they were  negative starting in 2000, with negative returns reaching 22.1 percent in  2002. (See fig. 7.) 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.
A stock market decline as severe as the one experienced from  2000 through 2002 can have a devastating effect on the funding of plans  that had invested heavily in stocks. For example, 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. Over that same general period, stocks in the S&P 500 had a  negative return of 38 percent.
In addition to the possible effect of the stock market’s decline, a drop in  interest rates likely had a negative effect on plan funding levels by  increasing plan termination costs. Lower interest rates increase plan  termination liabilities by increasing the present value of future benefit  payments, which in turn increases the purchase price of group annuity  contracts used to terminate defined-benefit pension plans. For example, a  PBGC analysis indicates that a drop in interest rates of 1 percentage point,  from 6 percent to 5 percent, increased the termination liabilities of the  Bethlehem Steel pension plan by about 9 percent, which indicates the cost  of terminating the plan through the purchase of a group annuity contract  would also have increased.
Relevant interest rates may have declined 3 percentage points or more  since 1990. For example, interest rates on long-term high-quality  corporate bonds approached 10 percent at the start of the 1990s, but were  below 7 percent at the end of 2002. (See fig. 8.)
section_title: Minimum Funding Rules and Variable-Rate Premiums Did Not Prevent Plans from Being Severely Underfunded
paragraphs: IRC minimum funding rules and ERISA variable rate premiums, 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. However, plan funding is measured using  current liabilities, which a PBGC analysis indicates have been typically  less than termination liabilities. Additionally, 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.
While minimum funding rules may encourage sponsors to better fund their  plans, the rules require sponsors to assess plan funding using current  liabilities, which a PBGC analysis indicates have been typically less than  termination liabilities. Current and termination liabilities differ because  the assumptions used to calculate them differ. For example, some plan  participants may retire earlier if a plan is terminated than they would if the  plan continues operations, and lowering the assumed retirement age  generally increases plan liabilities, especially if early retirement benefits  are subsidized. With respect to two of the terminated underfunded pension  plans that we examine, for example, a PBGC analysis indicates:
The retirement age assumption for the Anchor Glass pension plan on an  ongoing plan basis was 65 for separated vested participants. However, the  retirement age assumption appropriate for those participants on a  termination basis was 58—a decrease of 7 years. According to PBGC,  changing retirement age assumptions for all participants, including  separated vested participants, resulted in a net increase in plan liabilities  of about 4.6 percent.
The retirement age assumption for the Bethlehem Steel pension plan on an  ongoing plan basis was 62 for those active participants eligible for  unreduced benefits after 30 years of service. On the other hand, the  retirement age assumption for them on a plan termination basis was  55—the earliest retirement age. According to PBGC, decreasing the  assumed retirement age from 62 to 55 approximately doubled the liability  for those participants.
As shown in appendix IV, changes in the interest rates used to calculate  termination and current liabilities also play a role in determining to what  extent termination liabilities differ from current liabilities.
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 cash 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 the 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.
Another ERISA provision, concerning the payment of variable-rate  premiums, is also designed to encourage employers to better fund their  plans. As with minimum funding rules, the variable-rate premium did not  provide sufficient incentives for the sponsors of the plans that we  reviewed to make the contributions necessary to adequately fund their  plans. None of the three underfunded plans that we reviewed, which  became losses to the single-employer program in 2002 and 2003, paid a  variable-rate premium in the 2001 plan year. Plans are exempt from the  variable-rate premium if they are at the full-funding limit in the year  preceding the premium payment year, in this case 2000, after applying any  contributions and credit balances in the funding standard account. Each of  these three plans met this criterion.
section_title: PBGC Faces Long- Term Financial Risks from a Potential Imbalance of Assets and Liabilities
paragraphs: Two primary risks threaten the long-term financial viability of the single- employer program. The greater risk concerns the program’s liabilities:  large losses, due to bankrupt firms with severely underfunded pension  plans, could continue or accelerate. This could occur if returns on  investment remain poor, interest rates stay low, and economic problems  persist. More troubling for liabilities is the possibility that structural  weaknesses in industries with large underfunded plans, including those  greatly affected by increasing global competition, combined with the  general shift toward defined-contribution pension plans, could jeopardize  the long-term viability of the defined-benefit system. On the asset side,  PBGC also faces the risk that it may not receive sufficient revenue from  premium payments and investments to offset the losses experienced by  the single-employer program in 2002 or that this program may experience  in the future. This could happen if program participation falls or if PBGC  earns a return on its assets below the rate it uses to value its liabilities.
subsections: section_title: Several Factors Affect the Degree to Which Plans Are Underfunded and the Likelihood That Plan Sponsors Will Go Bankrupt
paragraphs: Plan terminations affect the single-employer program’s financial condition  because PBGC takes responsibility for paying benefits to participants of  underfunded terminated plans. Several factors would increase the  likelihood that sponsoring firms will go bankrupt, and therefore will need  to terminate their pension plans, and the likelihood that those plans will be  underfunded at termination. Among these are poor investment returns,  low interest rates, and continued weakness in the national economy or  specific sectors. Particularly troubling may be structural weaknesses in  certain industries with large underfunded defined-benefit plans.
Poor investment returns from a decline in the stock market can affect the  funding of pension plans. To the extent that pension plans invest in stocks,  the decline in the stock market will increase the chance that plans will be  underfunded should they terminate. A Greenwich Associates survey of  defined-benefit plan investments indicates that 59.4 percent of plan assets  were invested in stocks in 2002. Clearly, the future direction of the stock  market is very difficult to forecast. From the end of 1999 through the end  of 2002, total cumulative returns in the stock market, as measured by the  S&P 500, were negative 37.6 percent. In 2003, the S&P 500 has partially  recovered those losses, with total returns (from a lower starting point) of  14.7 percent through the end of September. From January 1975, the  beginning of the first year following the passage of ERISA, through  September 2003, the average annual compounded nominal return on the  S&P 500 equaled 13.5 percent.
A decline in asset values can be particularly problematic for plans if  interest rates remain low or fall, which raises plan liabilities, all else equal.  The highest allowable discount rate for calculating current plan liabilities,  based on the 30-year U.S. Treasury bond rate, has been no higher than  7.1 percent since April, 1998, lower than any previous point during the  1990s. Falling interest rates raise the price of group annuities that a  terminating plan must purchase to cover its promised benefits and  increase the likelihood that a terminating plan will not have sufficient  assets to make such a purchase. An increase in liabilities due to falling  interest rates also means that companies may be required under the  minimum funding rules to increase contributions to their plans. This can  create financial strain and increase the chances of the firm going  bankrupt, thus increasing the risk that PBGC will have to take over an  underfunded plan.
Economic weakness can also lead to greater underfunding of plans and to  a greater risk that underfunded plans will terminate. For many firms, slow  or declining economic growth causes revenues to decline, which makes  contributions to pension plans more difficult. Economic sluggishness also  raises the likelihood that firms sponsoring pension plans will go bankrupt.  Three of the last five annual increases in bankruptcies coincided with  recessions, and the record economic expansion of the 1990s is associated  with a substantial decline in bankruptcies. Annual plan terminations  resulting in losses to the single-employer program rose from 83 in 1989 to  175 in 1991, and after declining to 65 in 2000, the number reached 93 in  2001.
Weakness in certain industries, particularly the airline and automotive  industries, may threaten the viability of the single-employer program.  Because PBGC has already absorbed most of the pension plans of steel  companies, it is the airline industry, with $26 billion of total pension  underfunding, and the automotive sector, with over $60 billion in  underfunding, that currently represent PBGC’s greatest future financial  risks. In recent years, profit pressures within the U.S. airline industry have  been amplified by severe price competition, recession, terrorism, the war  in Iraq, and the outbreak of Severe Acute Respiratory Syndrome (SARS),  creating recent bankruptcies and uncertainty for the future financial  health of the industry. As one pension expert noted, a potentially  exacerbating risk in weak industries is the cumulative effect of  bankruptcy: if a critical mass of firms go bankrupt and terminate their  underfunded pension plans, others, in order to remain competitive, may  also declare bankruptcy to avoid the cost of funding their plans.
Because the financial condition of both firms and their pension plans can  eventually affect PBGC’s financial condition, PBGC tries to determine how  many firms are at risk of terminating their pension plans and the total  amount of unfunded vested benefits. According to PBGC’s fiscal year  2002 estimates, the agency is at potential risk of taking over $35 billion in  unfunded vested benefits from plans that are sponsored by financially  weak companies and could terminate. Almost one-third of these  unfunded benefits, about $11.4 billion, are in the airline industry.  Additionally, PBGC estimates that it could become responsible for over  $15 billion in shutdown benefits in PBGC-insured plans.
PBGC uses a model called the Pension Insurance Modeling System (PIMS)  to simulate the flow of claims to the single-employer program and to  project its potential financial condition over a 10-year period. This model  produces a very wide range of possible outcomes for PBGC’s future net  financial position.
section_title: Revenue from Premiums and Investments May Not Offset Program’s Current Deficit or Possible Future Losses
paragraphs: To be viable in the long term, the single-employer program must receive  sufficient income from premiums and investments to offset losses due to  terminating underfunded plans. A number of factors could cause the  program’s revenues to fall short of this goal or decline outright. For  example, fixed-rate premiums would decline if the number of participants  covered by the program decreases, which may happen if plans leave the  system and are not replaced. Additionally, the program’s financial  condition would deteriorate to the extent investment returns fall below  the assumed interest rate used to value liabilities.
Annual PBGC income from premiums and investments averaged  $1.3 billion from 1976 to 2002, in 2002 dollars, and $2 billion since  1988, when variable-rate premiums were introduced. Since 1988,  investment income has on average equaled premium income, but has  varied more than premium income, including 3 years in which investment  income fell below zero. (See fig. 9.)
Premium revenue for PBGC would likely decline if the total number of  plans and participants terminating their defined-benefit plans exceeded  the new plans and participants joining the system. This decline in  participation would mean a decline in PBGC’s flat-rate premiums. If more  plans become underfunded, this could possibly raise the revenue PBGC  receives from variable-rate premiums, but would also be likely to raise the  overall risk of plans terminating with unfunded liabilities. Premium  income, in 2002 dollars, has fallen every year since 1996, even though the  Congress lifted the cap on variable-rate premiums in that year.
The decline in the number of plans PBGC insures may cast doubt on its  ability to increase premium income in the future. 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, 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. (See fig 10.) In addition, a growing percentage of  plans have recently become hybrid plans, such as cash-balance plans, that  incorporate characteristics of both defined-contribution and defined- benefit plans. Hybrid plans are more likely than traditional defined-benefit  plans to offer participants the option of taking benefits as a lump-sum  distribution. If the proliferation of hybrid plans increases the number of  participants leaving the program by taking lump sums instead of  retirement annuities, over time this would reduce the number of plan  participants, thus potentially reducing PBGC’s flat-rate premium revenue.Unless something reverses these trends, PBGC may have a shrinking plan  and participant base to support the program in the future and that base  may be concentrated in certain, potentially more vulnerable industries.
Even more problematic than the possibility of falling premium income  may be that PBGC’s premium structure does not reflect many of the risks  that affect the probability that a plan will terminate and impose a loss on  PBGC. While PBGC charges plan sponsors a variable-rate premium based  on the plan’s level of underfunding, premiums do not consider other  relevant risk factors, such as the economic strength of the sponsor, plan  asset investment strategies, the plan’s benefit structure, or the plans  demographic profile. Because these affect the risk of PBGC having to take  over an underfunded pension plan, it is possible that PBGC’s premiums  will not adequately and equitably protect the agency against future losses.  The recent terminations of Bethlehem Steel, Anchor Glass, and Polaroid,  plans that paid no variable-rate premiums shortly before terminating with  large underfunded balances, lend some evidence to this possibility.  Sponsors also pay flat-rate premiums in addition to variable-rate  premiums, but these reflect only the number of plan participants and not  other risk factors that affect PBGC’s potential exposure to losses. Full- funding limitations may exacerbate the risk of underfunded terminations  by preventing firms from contributing to their plans during strong  economic times when asset values are high and firms are in the best  financial position to make contributions.
It may also be difficult for PBGC to diversify its pool of insured plans  among strong and weak sponsors and plans. In addition to facing firm- specific risk that an individual underfunded plan may terminate, PBGC  faces market risk that a poor economy may lead to widespread  underfunded terminations during the same period, which potentially could  cause very large losses for PBGC. Similarly, PBGC may face risk from  insuring plans concentrated in vulnerable industries that may suffer  bankruptcies over a short time period, as has happened recently in the  steel and airline industries. One study estimates that the overall premiums  collected by PBGC amount to about 50 percent of what a private insurer  would charge because its premiums do not account for this market risk.
The net financial position of the single-employer program also depends  heavily on the long-term rate of return that PBGC achieves from the  investment of the program’s assets. All else equal, PBGC’s net financial  condition could improve if its total net return on invested assets exceeded  the discount rate it used to value its liabilities. For example, between  1993 and 2000 the financial position of the single-employer program  benefited from higher rates of return on its invested assets and its financial  condition improved. However, if the rate of return on assets falls below  the discount rate, PBGC’s finances would worsen, all else equal. As of  September 30, 2002, PBGC had approximately 65 percent of its single- employer program investments in U.S. government securities and  approximately 30 percent in equities. The high percentage of assets  invested in Treasury securities, which typically earn low yields because  they are considered to be relatively “risk-free” assets, may limit the total  return on PBGC’s portfolio. Additionally, PBGC bases its discount rate on  surveys of insurance company group annuity prices, and because PBGC  invests differently than do insurance companies, we might expect some  divergence between the discount rate and PBGC’s rate of return on assets.  PBGC’s return on total invested funds was 2.1 percent for the year ending  September 30, 2002, and 5.8 percent for the 5-year period ending on that  date. For fiscal year 2002, PBGC used an annual discount rate of  5.70 percent to determine the present value of future benefit payments  through 2027 and a rate of 4.75 percent for payments made in the  remaining years.
The magnitude and uncertainty of these long-term financial risks pose  particular challenges for the PBGC’s single-employer insurance program  and potentially for the federal budget. In 1990, we began a special effort to  review and report on the federal program areas we considered high risk  because they were especially vulnerable to waste, fraud, abuse, and  mismanagement. In the past, we considered PBGC to be on our high-risk  list because of concerns about the program’s viability and about  management deficiencies that hindered that agency’s ability to effectively  assess and monitor its financial condition. The current challenges to  PBGC’s single-employer insurance program concern immediate as well as  long-term financial difficulties, which are more structural weaknesses  rather than operational or internal control deficiencies. Nevertheless,  because of serious risks to the program’s viability, we have placed the  PBGC single-employer insurance program on our high-risk list.
section_title: Several Reforms Might Reduce the Risks to the Program’s Financial Viability
paragraphs: Several types of reforms might be considered to reduce the risks to the  single-employer program’s long-term financial viability. These reforms  could be made to  strengthen funding rules applicable to poorly funded plans;  improve the availability of information about plan investments,  termination funding status, and program guarantees.
Several variations exist within these options.
subsections: section_title: Strengthening Plan Funding Rules Might Reduce Program Risks
paragraphs: GAO-03-313. more to their plan than is necessary to cover accrued future benefits.Raising these limitations might result in pension plans being better funded,  decreasing the likelihood that they will be underfunded should they  terminate.
section_title: Modifying Program Guarantee Would Decrease Plan Underfunding
paragraphs: Modifying certain guaranteed benefits could decrease losses incurred by  PBGC from underfunded plans. This approach could preserve plan assets  by preventing additional losses that PBGC would incur when a plan is  terminated. However, participants would lose benefits provided by some  plan sponsors. ERISA could be amended to:
Phase in the guarantee of shutdown benefits. PBGC is concerned about its  exposure to the level of shutdown benefits that it guarantees. Shutdown  benefits provide additional benefits, such as significant early retirement  benefit subsidies 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. Phasing in guarantees from the date of the applicable shutdown  could decrease the losses incurred by PBGC from underfunded plans.However, 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.
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. 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.
section_title: Restructuring the Program’s Premium Structure Might Improve Its Financial Viability
paragraphs: PBGC’s premium rates could be increased or restructured to improve  PBGC’s financial condition. Changing premiums could increase PBGC’s  revenue or provide an incentive for plan sponsors to better fund their  plans. However, premium changes that are not based on the degree of risk  posed by different plans may prompt financially healthy companies to exit  the defined-benefit system and discourage other plan sponsors from  entering the system. Various actions could be taken to reduce guaranteed  benefits. ERISA could be amended to:
Increase or restructure variable-rate premium. The current variable- rate premium of $9 per $1,000 of unfunded liability could be increased.  The rate could also be adjusted so that plans with less adequate  funding pay a higher rate. Premium rates could also 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.
Increase fixed-rate premium. The current fixed rate of $19 per  participant annually could be increased. Since the inception of PBGC,  this rate has been raised four times, most recently in 1991 when it was  raised from  $16 to $19. Such increases generally raise premium income for PBGC,  but the current fixed-rate premium has not reflected the changes in  inflation since 1991. By indexing the rate to the consumer price index,  changes to the premium would be consistent with inflation. However,  any increases in the fixed-rate premium would affect all plans  regardless of the adequacy of their funding.
section_title: Increasing Transparency of Plan Information Might Encourage Sponsors to Better Fund Plans, Reducing Program Risks
paragraphs: 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. ERISA could  be amended to:
Disclose information on plan investments. Information on the  allocation of plan investments among asset classes—such as equity or  fixed income—is available from Form 5500s prepared by plan  sponsors, but that information is not affirmatively furnished 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. Improving the  accessibility of plan asset allocation information 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 becomes  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.
Disclose 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.
Disclose benefit guarantees to additional participants. As with the  disclosure of plan funding status, only participants of plans below the  funding threshold receive notices on the level of program guarantees  should their plan terminate. Termination of a severely underfunded  plan can significantly reduce the benefits participants receive. For  example, 59-year old pilots were expecting annual benefits of $110,000  per year on average when the U.S. Airways plan was terminated in  2003, while the maximum PBGC-guaranteed benefit at age 60 is $28,600  per year. Expanding the circumstances under which plan sponsors  must notify participants of PBGC guarantees may enable more  participants to better plan for their retirement.
Additionally, in 1997, we reported that the current cash-based budget for  federal insurance programs, such as the single-employer pension  insurance program generally provides incomplete and misleading  information on the cost and fiscal impact of those programs. We stated  that accrual-based reporting would recognize the cost of the insurance  commitment when the decision is made to provide the insurance,  regardless of when the cash flows occur. This earlier recognition of the  cost of the government’s commitment would, among other things, provide  an opportunity to control costs and build budget reserves for future  claims. However, we also reported that agencies, such as PBGC, might  need to develop and test methodologies to generate the risk-assumed cost  estimates critical to the successful implementation of accrual-based  budgeting for insurance programs. In its comments on our report, OMB  stated that, while it agreed with our conclusions and would like to pursue  such improvements, it was not doing so because it did not have the  expertise that would be required. Given the record losses that the single- employer pension insurance program sustained in 2002 and the  deteriorating financial condition of PBGC it is more important than ever to  acquire the necessary expertise and invest in the development of loss  estimation methodologies and tools.
section_title: Conclusion
paragraphs: While the recent decline in the single-employer program’s financial  condition is not an immediate crisis, threats to the program’s long-term  viability should be addressed. The insolvency of PBGC potentially  threatens the retirement security of millions of Americans because  termination of severely underfunded plans can significantly reduce the  benefits participants receive. It also poses risks to the general taxpaying  public who ultimately would be made responsible for paying benefits that  PBGC is unable to afford. These risks require that meaningful, if perhaps  difficult, steps be taken that improve the long-term funding status of plans  and accountability of plan sponsors, especially those that represent a clear  risk to PBGC and plan participants and their beneficiaries. In contrast,  reforms intended to provide immediate relief to struggling plan sponsors—  such as exempting plans from the additional funding requirement or  increasing the discount rate—might actually increase the risk that plan  sponsors terminate with severely underfunded plans in the not so distant  future if the economic fortunes of those sponsors do not improve.
The factors contributing to the deterioration of PBGC’s financial condition  go beyond the effects of the recent economic downturn. For example,  current funding rules do not provide adequate protection to PBGC or  workers and retirees against losses from financially weak sponsors with  significantly unfunded benefits, leaving PBGC to pay benefits at least to  guaranteed levels. In addition, PBGC guarantees other types of benefits,  such as shutdown benefits, that employers have promised their employees  but are not required to fund until shutdown occurs. Furthermore, the  premiums paid by pension sponsors to participate in the single-employer  program do not account for all the risks posed by plans and, therefore,  some sponsors may not be paying enough to compensate PBGC for the  risks it undertakes. Although these issues can affect employee retirement  funds, employers who are going bankrupt may not be required to notify  pension participants of the funding status of their pensions, leaving  participants unable to plan for a future that may include less income than  they were anticipating.
In addition to the reforms in the administration’s proposal, the Treasury  Department, Labor Department, and PBGC are considering several areas—  funding rules, actuarial assumption, and other areas such as PBGC  premiums—for reform. However, the challenges facing PBGC suggest that  a broader, more comprehensive response is needed. For example, as we  stated in an earlier report, the interest rate used for current liability  calculation should reflect the group annuity purchase rate. However, any  changes to the interest rate should consider related provisions such as  averaging, minimum and maximum rates, and changes to the mortality  table. Furthermore, irrespective of the discount rate chosen, differences in  plan cash flows should be given consideration in making any changes to  the current funding standards. Without a comprehensive approach, efforts  to improve the long-term financial condition of PBGC may not be  effective.
section_title: Matters for Congressional Consideration
paragraphs: Given the multidimensional and serious nature of the financial risks to  PBGC’s single-employer insurance program, to millions of pension plan  participants and potentially to the federal budget, the Congress should  consider pension reform that is comprehensive in scope and balanced in  effect. Such a comprehensive response should include changes to  strengthen plan funding, especially for underfunded plans, and improve  the transparency of plan information as well as consider proposals to  restructure program guarantees, for example those concerning shutdown  benefits. In addition, PBGC’s premium structure should be re-examined to  see whether premiums can better reflect the risk posed by various plans to  the pension system. In any case, reforms in these areas should be based on  a thorough analysis of their effects on the potentially competing interests  of protecting retirees’ pensions and minimizing the burden on sponsors.
Essential elements of this reform would include proposals to require plans  to calculate liabilities on a termination basis and disclose this information  to all participants annually. Particularly with regard to disclosure, the  Congress should consider requiring that all participants receive  information about plan investments and the minimum benefit amount that  PBGC guarantees should their plan be terminated.
To improve the transparency of the potential cost to the government and  taxpayers of the PBGC’s pension guarantees, the Congress may also wish  to encourage the development and reporting of accrual based risk- assumed cost estimates in the federal budget in conjunction with the  current cash-based estimates. Such forward looking estimates could more  clearly reflect the financial condition of the program and provide  information and incentives necessary to assess the future implications of  programmatic decisions.
section_title: Agency Comments
paragraphs: We provided a draft of this report to Labor, Treasury, and PBGC. PBGC  also provided written comments, which appear in appendix V, that  incorporate comments from the Treasury and Labor Departments and  represent the views of the Commerce Department. 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 or Charles A. Jeszeck at (202) 512-7036. Other contacts and  acknowledgments are listed in appendix VI.
section_title: Appendix I: Scope and Methodology
paragraphs: To identify the changes in the financial condition of the single-employer  program, we reviewed and analyzed Pension Benefit Guaranty  Corporation (PBGC) financial statements for 1991 through 2002, and  obtained additional financial information on the program from PBGC for  1974 through 1990. To identify the factors that contributed to recent  changes in the single-employer program’s financial condition, we  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. We also reviewed analyses of the program’s financial  condition and plan funding issues prepared by actuaries and other pension  professionals. To examine the difference between termination and current  liability, and identify the factors that cause that difference, we obtained  summary level termination liability data, and limited data for specific  plans, submitted by plans to PBGC under section 4010 of the Employee  Retirement and Income Security Act (ERISA) of 1974, as amended.
To identify the primary risks to the long-term viability of the program and  options to address the challenges facing the single-employer program, we  interviewed pension experts at PBGC, at the Employee Benefits Security  Administration (EBSA) of the Department of Labor, and in the private  sector and reviewed analyses and other documents provided by them.  These include data on PBGC’s income, cash flows, premium structure and  base, investments, and assets and liabilities. To obtain additional  information as to the risks facing PBGC from certain industries, we  discussed with PBGC, and reviewed annual and actuarial reports for, the  2003 distress termination of the U.S. Airways pension plan for pilots.
To determine what changes to the single-employer program might be  considered to reduce the risks that it faces, we reviewed and analyzed  proposals from the administration, the American Academy of Actuaries,  and various pension plan organizations and legislative proposals  introduced during the 108th Congress. We also spoke with officials from  PBGC, EBSA, and the Department of the Treasury; research actuaries; and  individuals from organizations that represent plan sponsors.
We performed our work at PBGC and EBSA from April through September  2003 in accordance with generally accepted government auditing  standards.
section_title: Appendix II: Key Legislative Changes That Affected the Single-Employer Program
paragraphs: As part of the ERISA, the Congress established PBGC to administer the  federal insurance program. Since 1974, the Congress has amended ERISA  to improve the financial condition of the insurance program and the  funding of single-employer plans (see table 1).
section_title: Appendix III: The Administration Proposal for Pension Reform
paragraphs: On July 8, 2003, the U.S. Treasury Department announced “The  Administration Proposal to Improve the Accuracy and Transparency of  Pension Information.” The proposal presented four areas of change in  order to improve pension security for Americans: (1) the accuracy of the  pension liability discount rate, (2) the transparency of pension plan  information, (3) safeguards against pension underfunding, and  (4) comprehensive funding reforms. Subsequent congressional testimony  by the Treasury Department and the U.S. Labor Department highlighted  other areas of the pension system that the administration is considering  reforming.  1.  Improving the Accuracy of the Pension Liability Discount Rate  Sponsors must use a discount rate to calculate the current value of their  plans’ pension obligations and of lump-sum withdrawals. Currently, this  rate is based on the rate of 30-year Treasury bonds, securities that have  not been newly issued since 2001. There is concern that too high a  discount rate would lead to pension underfunding, while too low a rate  would cause businesses to have to put more money into their pension  funds to pay promised benefits. The administration recommended  replacing the 30-year Treasury bond rate with a yield curve based on high- quality, long-term corporate bond rates. It claims that pension discount  rates should reflect the risk embodied in assets held by insurance  companies to make group annuity payments, and that these assets consists  largely of highly rated corporate-issued bonds.
Similarly, the administration proposed using the same yield curve to  discount lump-sum distributions from plans. Currently, lump sums are  calculated using the 30-year Treasury rate, a rate that may differ from the  one used to calculate current plan liabilities. The administration proposal  would have plans discounting lump sums and plan liabilities at the same  rate. For both lump sums and liabilities, the administration proposes  phasing in the yield curve beginning in the third year, with the phase-in  complete by the fifth year.
Sponsors would compute liabilities by choosing rates along the yield curve  based on when the plan is due to make benefit payments. Thus, sponsors  would discount benefits due farther in the future at a longer-term rate than  those paid in the near future. Since long-term rates tend to exceed short- term rates, this would imply that plans with a higher proportion of older  workers and retirees would use lower rates to discount their liabilities  than those with younger workers. Similarly, the proposal would also have  plans use a discount rate along the yield curve for lump sums that reflects  the life expectancy of retirees, with lump sums for older workers  discounted at a shorter-term rate than those for younger workers.
To further increase pension discount rate accuracy, the administration  further proposed reducing the use of smoothing in calculating plan  liabilities. Sponsors currently use a discount rate on plan liabilities based  on a 4-year moving average of interest rates. The administration claimed  that such smoothing reduces the accuracy of liability measures because  the discount rate is not necessarily based on current market conditions,  which may mask changes in plan solvency. The proposal would reduce the  smoothing period, over a 3-year phase-in beginning in the third year, to a  90-day moving average.  2.  Increasing the Transparency of Pension Plan Information  To increase transparency, the administration proposal calls for plans to  disclose liabilities on a termination basis, as well as on a current liability  basis, in their annual reporting. Currently, a sponsor must disclose its  plan’s current liability, which is intended to reflect the value of liabilities in  an ongoing plan, using a discount rate based on the 30-year Treasury bond  rate. Termination liability reflects the cost to a company of paying an  insurer to meet its pension obligations should the plan terminate. This is  calculated by using a PBGC interest factor, which is based on a survey of  insurance companies and may reflect group annuity purchase rates, rather  than by using the 30-year Treasury bond rate. Termination liability is often  higher than current liability.
The proposal would also have pension plans with more than $50 million of  underfunding make public their plan assets, liabilities, and funding ratios,  information that PBGC already collects. Currently, section 4011 of the  ERISA, as amended, requires that sponsors of plans that are less than  90 percent funded send notices to workers and retirees describing the  plan’s funding status and the limits of PBGC guarantees.
The proposal would also have plans disclose liabilities calculated by using  a duration-matched yield curve, even before the yield curve is fully phased  in for funding purposes. That is, sponsors would disclose the value of their  liabilities by using a discount rate on the yield curve that reflects the  duration of its plan liabilities, with a plan with more benefits owed far in  the future using a longer-term discount rate than one with more benefits  owed in the near future.  3.  Strengthening Safeguards against Pension Underfunding  Currently, a plan generally may not provide unfunded or unsecured benefit  increases greater than $10 million if the plan’s funding ratio falls below  60 percent of current liability. To strengthen pension funding, the  administration proposed prohibiting benefit increases by the plan  sponsored by firms with a credit rating below investment grade and with  a funding ratio below 50 percent of termination, as opposed to current  liability. In addition, the plan would also be frozen—with no accruals  resulting from additional service, age or salary growth—and lump-sum  payments would also be prohibited unless the employer contributed cash  or provided security to fully fund any added benefits. For firms already in  bankruptcy, the administration would fix the benefit guarantee as of the  date the plan sponsor filed for bankruptcy.  4.  Supporting Comprehensive Funding Reforms  In addition to the reforms above, the proposal states that the  administration is exploring additional reforms to improve the funding  status of defined benefit plans. These include:
Changing rules regarding minimum contributions of underfunded  plans.
Raising limits on tax-deductible contributions.
Limiting the use of credit balances.
Reducing new benefit amortization periods.
Updating mortality tables.
Making retirement assumptions accurate.
Making lump-sum estimates accurate.
Limit or eliminate certain unfunded benefit guarantees.
Restructuring PBGC premiums to reflect risk.
Applying the same principles of accuracy and transparency to the  multiemployer pension program.
section_title: Appendix IV: Differences in Interest Rate Calculations Contribute to Differences between Termination and Current Liabilities
paragraphs: 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. Interest rates are a key assumption in  calculating the present value of future pension benefits, and the degree  that the interest rates used to calculate termination and current liabilities  differ would contribute to the degree that the two liability measures differ.  Generally:
Liabilities determined on a termination basis should be calculated using an  interest rate that reflects the factors that insurance companies consider in  pricing the group annuities they sell to pension plan sponsors who  terminate their defined benefit plans. However, information needed to  determine actual group annuity purchase rates is not available since  annuity purchases are private transactions between insurance companies  and purchasers. Instead, under PBGC regulations, sponsors who are  required by ERISA, as amended, to report plan termination liability  information to PBGC, calculate that liability using a rate published by  PBGC. PBGC determines that rate based on surveys of insurance  companies performed by the American Council of Life Insurers.
Current liabilities are to be calculated using an interest rate from within a  range of permissible rates based on 30-year Treasury rates, as specified in  the Internal Revenue Code.
Figure 11 shows that funding ratios using termination liabilities were  typically lower than funding ratios using current liabilities, for plans  reporting termination liabilities to PBGC under section 4010 of ERISA, as  amended. In 1996, for example, the average funding ratio based on  termination liability was 69 percent, but the average funding ratio based  on current liability was 99 percent. Termination liability funding ratios are  typically lower than current liability funding ratios because termination  liabilities are typically greater than current liabilities.
Figure 12 shows that the PBGC rate used to calculate termination  liabilities, and the maximum and minimum rates used to calculate current  liabilities, varied considerably 1996 through 2001. In the first 3 years,  PBGC termination liability rates were typically less than current liability  rates, but in the following 2 years, termination liability rates were typically  higher than current liability rates. Lower interest rates result in higher  liability values, and higher rates result in lower liability values. As a result,  when the PBGC termination rate was high, relative to the current liability  rate, termination liabilities would be reduced relative to current liabilities,  causing the gap between the two funding ratios to narrow, as it did in  2001.
section_title: Appendix VI: GAO Contacts and Staff Acknowledgments
subsections: section_title: Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to those named above, Joseph Applebaum, Mark M. Glickman,  Corinna Nicolaou, David Noguera, John M. Schaefer, George A. Scott, and  Roger J. Thomas made important contributions to this report.