Pension Benefit Guaranty Corporation: Financial Challenges Highlight Need for Improved Governance and Management
Released: 2009-05-20T00:00:00

Letter

Background

PBGC was created by the Employee Retirement Income Security Act of 1974 (ERISA) to pay benefits to participants in private DB plans in the event that an employer could not. PBGC may pay benefits, up to specified limits, if a plan does not have sufficient assets itself to pay promised benefits and the sponsoring company is in financial distress. PBGC’s single-employer insurance program guarantees benefits up to $4,500 per month for age-65 retirees of plans terminating in 2009, with lower guarantees for those who retire before age 65. Currently, PBGC insurance covers 44 million participants, including retirees, in over 29,000 DB plans. PBGC pays monthly retirement benefits to more than 640,000 retirees in 3,860 pension plans that have ended, and is responsible for the current and future pensions of about 1.3 million people. ERISA also requires PBGC to encourage the continuation and maintenance of voluntary private pension plans.

PBGC receives no funds from general tax revenues. Operations are financed by insurance premiums set by Congress and paid by sponsors of DB plans, recoveries from the companies formerly responsible for the plans, and investment income of assets from pension plans taken over, or “trusteed,” by PBGC. Under current law, other than statutory authority to borrow up to $100 million from the Treasury Department, no substantial source of funds is available to PBGC if it runs out of money. In the event that PBGC were to exhaust all of its holdings, benefit payments would have to be drastically cut unless Congress were to take action to provide support.

The assets and liabilities that PBGC accumulates from trusteeing plans has increased rapidly over the last 6 years or so. This is largely due to the termination, typically through bankruptcies, of a number of very large, underfunded plan sponsors. In fact, 8 of the top 10 firms presenting claims against PBGC did so from 2003 to 2007. These top 10 claims alone currently account for over 60 percent of all of PBGC’s claims and are concentrated among firms representing the steel and airline industries. Overall, these industries accounted for about three-quarters of PBGC’s total claims and single-employer benefit payments in 2007.

In 2003, GAO designated PBGC’s single-employer program as high-risk, meaning that the program needs urgent Congressional attention and agency action. We specifically noted PBGC’s prior-year net deficit, as well as the risk of the termination among large, underfunded pension plans, as reasons for the program’s high-risk designation.

As part of our monitoring of PBGC as a high-risk agency we have highlighted additional challenges faced by the single-employer program. Among these concerns were the serious weaknesses that existed with respect to plan funding rules and that PBGC’s premium structure and guarantees needed to be re-examined to better reflect the risk posed by various plans. Additionally, the number of single-employer insured DB plans has been rapidly declining, and, among the plans still in operation, many have frozen benefits to some or all participants. Further, the prevalence of plans that are closed to new participants seems to imply that PBGC is likely to see a decline in insured participants, especially as insured participants seem increasingly likely to be retired (as opposed to active or current) workers.

PBGC has remained high-risk with each subsequent report in 2005, 2007, and, most recently, 2009. In our 2007 high risk update we noted that major pension legislation had been enacted which addressed many of the concerns articulated in our previous reports and testimonies on PBGC’s financial condition. The Deficit Reduction Act of 2005 (DRA) was signed into law on February 8, 2006 and included provisions to raise flat-rate premiums and create a new, temporary premium for certain terminated single-employer plans. Later that year the Pension Protection Act of 2006 (PPA) was enacted; it included a number of provisions aimed at improving plan funding and PBGC finances. The provisions aimed at improving plan funding included such measures as raising the funding targets DB plans must meet, reducing the period over which sponsors can “smooth” reported plan assets and liabilities, and restricting sponsors’ ability to substitute “credit balances” for cash contributions. Reforms aimed at shoring up PBGC revenues included a termination premium for some bankrupt sponsors, and limiting PBGC’s guarantee to pay certain benefits. However, the overall impact of PPA remains unclear; PPA did not fully close potential plan funding gaps, and provided special relief to plan sponsors in troubled industries. PBGC’s net financial position improved from 2005 to 2006 because some very large plans that were previously classified as probable terminations were reclassified to a reasonably possible designation as a result of the relief granted to troubled industries such as the airlines.

PBGC’s Financial Condition Has Likely Worsened Since September 2008

While PBGC’s deficit improved for fiscal year 2008, the fiscal year ended just prior to the severe market downturn, and it is likely that their net position looks different today. Since we last reported to Congress on PBGC, PBGC issued its fiscal year 2008 financials and reported that the net deficit for its insurance programs was $11.2 billion. In some ways, this was good news. PBGC’s net deficit reached a peak of $23.5 billion in 2004 largely as a result of a number of realized and probable claims that occurred during that year. However, the lower 2008 deficit may be a product of conditions that no longer exist. For example, PBGC’s net deficit is a resulting difference between its assets and its liabilities. (See figure 1 for the difference between PBGC assets and liabilities for both insurance programs from 1990 to 2008.) As of PBGC’s September 30, 2008 financial statement—even before the severe market downturn in October—PBGC saw an investment return of -6.5 percent over the year, which contributed to diminishing its assets from the prior year by about $5.5 billion. The net deficit improved, despite the performance of its assets, because of the decrease in its liabilities. According to PBGC, the improvement was due largely to successful negotiations in bankruptcy proceedings, a favorable change in interest factors used to value PBGC’s liabilities, and the fact that PBGC saw significant reductions to its liabilities for probable terminations. PBGC has likely seen its net financial condition hurt by increased exposure due to declines in funding levels of many large plans, from the termination of underfunded plans, and by an increase in its liabilities due to a likely decrease in the interest rates used to value its liabilities.

The current economic environment has likely increased the exposure PBGC faces from financially distressed sponsors with large, underfunded plans. The funding of many large plans has likely eroded as a result of the lowered financial health of many sponsors, thereby potentially increasing PBGC’s exposure to probable terminations, developments that the most recent estimates may not reflect. Estimating PBGC’s future claims has always been difficult to predict over the long-term due to the significant volatility in plan underfunding and sponsor credit quality over time. However, the current economic environment seems to have put sponsors under particular stress.

There is likely a wide range of industry sectors that have been affected by the current economic environment, and particularly the automotive sector. For example, the pension plans of Chrysler and General Motors (GM) today pose considerable financial uncertainty to PBGC. In the event that Chrysler or GM cannot continue to maintain their pension plans—such as in the case of liquidation or an asset sale—PBGC may be required to take responsibility for paying the benefits for the plans, which, as of the most current publicly available information, are underfunded by a total of about $29 billion.

Although it is impossible to know what the exact claims to PBGC would be if it took over Chrysler’s and GM’s pension plans, doing so would likely strain PBGC’s resources, because the automakers’ plans represent a significant portion of the benefits it insures. Further, from an administrative standpoint, PBGC would be presented with an unprecedented number of assets to manage as well as benefit liabilities to administer. For example, GM’s and Chrysler’s plans include roughly 900,000 participants, both those receiving benefits now and those who have earned benefits payable in the future, which would increase the total number of PBGC’s current or future beneficiaries by nearly 80 percent. Even with Chrysler’s bankruptcy and concern about GM’s viability, it is not certain that PBGC would take over responsibility for either plan. For example, a number of auto parts suppliers in Chapter 11 with collectively bargained pension plans have emerged from reorganization without terminating their pension plans.

While the events surrounding the automakers and their pension plans are clearly an area of concern for the PBGC, the recession has likely affected many industry sectors. Although, PBGC’s past claims have been concentrated to industries like steel and airlines, there is cause for concern that future claims will come from a much broader array of industries.

PBGC’s insurance programs held $63 billion in assets as of September 30, 2008, and the Corporation has stated it has sufficient liquidity to meet its obligations for a number of years. However, to the extent additional claims from vulnerable industries markedly increase PBGC’s accumulated deficit and decrease its long-run liquidity, there could be pressure for the federal government to provide PBGC financial assistance to avoid reductions in guaranteed payments to retirees or unsustainable increases in the premium burden on sponsors of ongoing plans.

PBGC’s overall exposure has increased for additional reasons. The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA), passed in December, grants funding relief to certain sponsors and delays the implementation of certain aspects of the PPA. WRERA makes several technical corrections to PPA and contains provisions designed to help pension plans and plan participants weather the current economic downturn. For a number of sponsors, this legislation may mean lower plan contributions than they would otherwise have had to pay under the phase- in of PPA and, at least temporarily, potentially increase levels of plan underfunding. As we noted in our 2009 high-risk update on PBGC, this legislation is likely to increase PBGC’s risk exposure, perhaps significantly.

Finally, PBGC’s newly-adopted investment policy may expose the Corporation to additional risk. The new policy reduces the proportion of PBGC assets allocated to fixed-income investments, such as Treasury and corporate bonds; increases its proportional holdings in international equities; and introduces new asset classes, such as private equity, emerging market debt and equities, high-yield fixed income, and private real estate. While the investment policy adopted in 2008 aimed to reduce PBGC’s deficit by investing in assets with a greater expected return, in a report last summer, we found that the new allocation will likely carry more risk than acknowledged by PBGC’s analysis.

Our assessment found that, although returns are indeed likely to grow with the new allocation, the risks are likely higher as well. Although it is important that the PBGC consider ways to optimize its portfolio, including higher return and diversification strategies, the agency faces unique challenges, such as PBGC’s need for access to cash in the short-term to pay benefits, which could further increase the risks it faces with any investment strategy that allocates significant portions of the portfolio to volatile or illiquid assets. According to PBGC the new allocation will be sufficiently diversified to mitigate the expected risks associated with the higher expected return. PBGC also asserted that it should involve less risk than the previous policy. The Congressional Budget Office has also pointed out such risks, saying that “the new strategy…increases the risk that PBGC will not have sufficient assets to cover retirees’ benefit payments when the economy and financial markets are weak.”

PBGC has only implemented portions of the policy. PBGC told us that it has begun the process of reducing the percentage of its assets in fixed- income investments, but it has not yet begun to increase its portfolio of certain asset classes, specifically private equity and real estate. PBGC also told us that the process it follows for its current implementation of the investment policy follows industry best practices for large transactions. However, PBGC officials also told us that the intended asset allocation targets set by the current implementation of this policy could easily be derailed if PBGC is required to assume the assets of very large and severely underfunded sponsors.

Improvements Needed to PBGC’s Governance and Management

PBGC’s Governance Structure Needs Improvement

PBGC’s board has limited time and resources to provide policy direction and oversight. PBGC’s three-member board, established by ERISA, includes only the Secretary of Labor, as the Chair of the Board, and the Secretaries of Commerce and Treasury. We noted that the board members have designated officials and staff within their respective agencies to conduct much of the work on their behalf and relied mostly on PBGC’s management to inform these board members’ representatives of pending issues. PBGC’s board members have numerous other responsibilities in their roles as cabinet secretaries and have been unable to dedicate consistent and comprehensive attention to PBGC.

Since PBGC’s inception, the board has met infrequently. In 2003, after several high-profile pension plan terminations, PBGC’s board began meeting twice a year (see figure 2). PBGC officials told us that it is a challenge to find a time when all three cabinet secretaries are able to meet, and in several instances the board members’ representatives officially met in their place. Currently, the PBGC board has not met face-to-face in over one year—since February 2008.

While the PBGC board has met more frequently since 2003, very little time is spent on addressing strategic and operational issues. According to corporate governance guidelines, boards should meet regularly and focus principally on broader issues, such as corporate philosophy and mission, broad policy, strategic management, oversight and monitoring of management, and company performance against business plans. However, our review of the board’s recorded minutes found that although some meetings devoted a portion of time to certain strategic and operational issues, such as investment policy, the financial status of PBGC’s insurance programs, and outside audit reviews, the board meetings generally only lasted about an hour.

The size and composition of PBGC’s board does not meet corporate governance guidelines. According to corporate governance guidelines published by The Conference Board, corporate boards should be structured so that the composition and skill set of a board is linked to the corporation’s particular challenges and strategic vision, and should include a mix of knowledge and expertise targeted to the needs of the corporation. We did not identify any other government corporations with boards as small as at PBGC. Government corporations’ boards averaged about 7 members, with one having as many as 15. In addition, PBGC is also exposed to challenges as the board, board members’ representatives, and the director have changed with the recent presidential transition, limiting the board’s institutional knowledge of the Corporation.

The revision of PBGC’s investment policy provides an example of the need for an active board to help oversee the Corporation’s challenges and strategic vision. We found that PBGC board’s 2004 and 2006 investment policy was not fully implemented. While the board assigned responsibility to PBGC for reducing equity holdings to a range of 15 to 25 percent of total investment, by 2008 the policy goal had not been met. Although the PBGC director and staff kept the board apprised of investment performance and asset allocation, we found no indication that the board had approved the deviation from its established policy or expected PBGC to continue to meet policy objectives. While PBGC’s Board revised the investment policy in February 2008, the board has not held a meeting to discuss the new policy’s implementation even though there has been a serious downturn in investment markets. In May 2009, PBGC officials told us that they have kept the new Board members—the Secretary of Labor, along with officials from the Departments of Commerce and Treasury—apprised of the progress in implementing the new investment policy.

In our July 2007 report on PBGC’s governance structure, we asked Congress to consider expanding PBGC’s board of directors, to appoint additional members who possess knowledge and expertise useful to PBGC’s responsibilities and can provide needed attention. Further, dedicating staff that are independent of PBGC’s executive management and have relevant pension and financial expertise to solely support the board’s policy and oversight activities may be warranted. In response to our finding, PBGC contracted with a consulting firm to identify and review governance models and provide a background report to assist the board in its review of alternative corporate governance structures. The consulting firm’s final report describes the advantages and disadvantages of the corporate board structures and governance practices of other government corporations and select private sector companies, and concludes that there are several viable alternatives for PBGC’s governance structure and practices.

As PBGC Relies Heavily on Its’ Contractor and Federal Workforce, A More Strategic Approach Is Needed

Although two-thirds of PBGC’s workforce includes contractor employees, PBGC’s strategic planning generally does not recognize contracting as a major aspect of PBGC activities (see figure 3). Since the mid-1980s, PBGC has had contracts covering a wide range of services, including the administration of terminated plans, payment of benefits, customer communication, legal assistance, document management, and information technology. As PBGC’s workload grew due to the significant number of large pension plan terminations, PBGC relied on contractors to supplement its workforce, acknowledging that it has difficulty anticipating workloads due to unpredictable economic conditions.

Last summer we reported that PBGC had begun to improve some of its contracting practices by to updating contracting policies and processes, upgrading the skills of Procurement Department staff, and better tracking contracting data. While we reported that PBGC had begun to implement performance-based contracting that offers the potential for better contract outcomes, PBGC officials recently told us that the new field benefit administration contracts will not be performance-based.

PBGC lacks a strategic approach to its acquisition and human capital management needs. PBGC’s strategic plan does not document how the acquisition function supports the agency’s missions and goals. Further, although contracting is essential to PBGC’s mission, we found that the Procurement Department is not included in corporate-level strategic planning. Based on these findings, we recommended that PBGC revise its strategic plan to reflect the importance of contracting and to project its vision of future contract use, and ensure that PBGC’s procurement department is included in agency-wide strategic planning. (Appendix I includes selected GAO recommendations on PBGC Governance and Management). PBGC disagreed with our recommendation to reflect the importance of contracting and incorporate its vision for future contractor use in its strategic planning documents, as it believes its recently issued strategic plan is sufficiently comprehensive. However, PBGC’s strategic plan only briefly mentions performance-based contracting, flexible staffing, and metrics for specific contracts, and therefore we believe that it does not reflect the important role contracting is playing in achieving PBGC’s mission.

PBGC also needs a more strategic approach for improving human capital management. We found that PBGC’s draft strategic human capital plan does not provide detailed plans for obtaining contract support or managing the workload fluctuations. While PBGC has made progress in its human capital management approach by taking steps to improve its human capital planning and practices—such as drafting a succession management plan—the Corporation lacked a formal, comprehensive human capital strategy, articulated in a formal human capital plan that includes human capital policies, programs, and practices. PBGC is generally able to hire staff in its key occupations—such as accountants, actuaries, and attorneys—and retain them at rates similar to those of the rest of the federal government. However, PBGC has had some difficulty hiring and retaining staff for specific occupations and positions, including executives and senior financial analysts. Since our report, PBGC officials told us that they have provided a human capital plan to the Office of Personnel Management (OPM) and are awaiting OPM feedback.

The need for a strategic approach to acquisition and human capital management is essential to ensure that PBGC is able to manage the administrative fluctuations of a pension insurance corporation. As noted earlier, General Motor’s and Chrysler’s plans include roughly 900,000 participants, both those receiving benefits now and those who have earned benefits payable in the future. These participants, if brought under PBGC administration, would raise the number of PBGC’s current or future beneficiary population by roughly 80 percent. While it is uncertain whether an automaker plan would ever be assumed by PBGC, the concentration of large numbers of plan beneficiaries among just two sponsors illustrates the potential for a sudden and unprecedented administrative workload at PBGC.

Conclusions

While PBGC has been on our High Risk list since 2003—and many of its challenges are long-term in nature—the recession and market down-turn has magnified the challenges it faces. When we last reported on PBGC’s financial challenges in September, we specifically mentioned the change in investment policy as a key challenge going forward. This is still the case, but even more recent events, such as legislative changes and the plight of the automakers and other financially weak sponsors in other industries, have the potential to expose PBGC to claims of a potentially unprecedented magnitude.

While many of the financial challenges are a result of long-term weaknesses that are in many ways structural, PBGC does have some degree of control over challenges it faces with respect to governance, oversight, and management. GAO has made many recommendations in these areas, but given the potentially immense financial challenges the Corporation faces, the need to act is only growing. It is unfortunate that, during a time of financial crisis, the PBGC board has not met in 15 months. However, PBGC not only needs a board that meets regularly, but also a board that can be active and commit the time to understanding the weight and urgency of the issues facing the Corporation. Ideally, a more robust board structure would be in place as soon as possible so that the board can address current challenges and anticipate new ones. The current situation has important implications for all PBGC stakeholders: plan sponsors, insured participants, insured beneficiaries, as well as the government and, ultimately, the taxpayers. PBGC should not have to take on significant, additional claims from severely underfunded pension plans before situation is recognized.

Chairman Kohl, Senator Martinez, and Members of the Committee, this concludes my prepared statement. I would be happy to respond to any questions you may have.

Appendix II: Selected GAO Reports and Testimonies Related to the Pension Benefit Guaranty Corporation

High Risk Series: An Update. GAO-09-271. Washington, D.C.: January 2009.

Pension Benefit Guaranty Corporation: Improvements Needed to Address Financial and Management Challenges. GAO-08-1162T. Washington, D.C.: September 24, 2008.

Pension Benefit Guaranty Corporation: Need for Improved Oversight Persists. GAO-08-1062. Washington, D.C.: September 10, 2008.

Pension Benefit Guaranty Corporation: Some Steps Have Been Taken to Improve Contracting, but a More Strategic Approach Is Needed. GAO-08-871. Washington, D.C.: August 18, 2008.

PBGC Assets: Implementation of New Investment Policy Will Need Stronger Board Oversight. GAO-08-667. Washington, D.C.: July 17, 2008.

Pension Benefit Guaranty Corporation: A More Strategic Approach Could Improve Human Capital Management. GAO-08-624. Washington, D.C.: June 12, 2008.

High Risk Series: An Update. GAO-07-310. Washington, D.C.: January 2007.

Pension Benefit Guaranty Corporation: Governance Structure Needs Improvements to Ensure Policy Direction and Oversight. GAO-07-808 Washington, D.C.: July 6, 2007.

PBGC’s Legal Support: Improvement Needed to Eliminate Confusion and Ensure Provision of Consistent Advice. GAO-07-757R. Washington, D.C.: May 18, 2007.

Private Pensions: Questions Concerning the Pension Benefit Guaranty Corporation’s Practices Regarding Single-Employer Probable Claims. GAO-05-991R. Washington, D.C.: September 9, 2005.

Private Pensions: The Pension Benefit Guaranty Corporation and Long- Term Budgetary Challenges. GAO-05-772T. Washington, D.C.: June 9, 2005.

Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules. GAO-05-294. Washington, D.C.: May 31, 2005.

Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance Program Faces Significant Long-Term Risks. GAO-04-90. Washington, D.C.: October 29, 2003.

Pension Benefit Guaranty Corporation Single-Employer Insurance Program: Long-Term Vulnerabilities Warrant ‘High Risk’ Designation. GAO-03-1050SP. Washington, D.C.: July 23, 2003.

Pension Benefit Guaranty Corporation: Statutory Limitation on Administrative Expenses Does Not Provide Meaningful Control. GAO-03-301. Washington, D.C.: February 28, 2003.

GAO Forum on Governance and Accountability: Challenges to Restore Public Confidence in U.S. Corporate Governance and Accountability Systems. GAO-03-419SP. Washington, D.C.: January 2003.

Appendix III: Contacts and Staff Acknowledgments

For further questions about this statement, please contact Barbara D. Bovbjerg at (202) 512-7215. Individuals making key contributions to this statement include Blake Ainsworth, Charles Ford, Jennifer Gregory, Craig Winslow, and Susannah Compton.

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