The United States Postal Service commenced operations on July 1, 1971, in accordance with the provisions of the Postal Reorganization Act of 1970 (P.L. 91-375). The Service is an independent establishment of the executive branch with a goal to operate on a break-even basis and cover its expenses almost entirely through postal revenues. The equity the U.S. government held in the former Post Office Department became the initial capital of USPS (approximately $3 billion), and the U.S. government remained responsible for all the liabilities attributable to operations of the former Post Office Department. At inception, the Postal Service did not have any unpaid liabilities to OPM for retirement benefits. At that time, USPS employees participated in the federal Civil Service Retirement System (CSRS), which provided them the same benefits as other federal employees, that is, their future retirement benefits would be paid by OPM based on payroll deductions and USPS contributions under provisions of law governing CSRS. With over 900,000 employees at the end of fiscal year 2000, USPS has the largest number of federal civilian employees, and Fortune magazine ranks it as the second largest employer in the United States. Similar to other federal career employees, USPS career employees participate in one of three federal retirement systems primarily administered by OPM: the Civil Service Retirement System, the Federal Employees Retirement System (FERS), and the CSRS Offset Plan. At the end of fiscal year 2000, nearly 786,000 USPS career employees, or 87 percent of the Service’s employees, were participating in one of the three federal retirement programs. The remaining 13 percent were casual labor and transitional employees who do not participate in the federal retirement plans. Of the total career employees, 263,383 employees (33.5 percent) participated in CSRS; 510,509 employees (65 percent) participated in FERS; and 12,021 employees (1.5 percent) participated in the CSRS Offset Plan. CSRS is administered by OPM, which maintains a Civil Service Retirement and Disability Fund (CSRDF) for federal employees. CSRS is a defined benefit retirement plan, which provides a basic annuity to participants. Benefit payments to federal retirees and their survivors participating in any of the three retirement plans are made from CSRDF. CSRS covers employees hired prior to January 1, 1984. Employees hired after December 31, 1983, are not eligible for coverage in CSRS, but participate in either FERS or the CSRS Offset Plan. Contributions to the CSRS plan are collected from the Service and its employees and deposited into OPM’s CSRDF, according to the proportionate sharing arrangement established in law. Participating USPS employees contribute in the same proportion and percentage amounts as most other civilian federal employees. USPS and its employees also contribute to Medicare at the rate prescribed by law. In addition to the contributions to CSRS discussed above, the Service is responsible for making additional contributions to CSRDF to fund the future retirement costs of increases to pay that the Service granted to employees under terms in new labor contracts and the annual COLAs to retirees, which were prescribed by law. The provisions for the Service to make these additional contributions to OPM were included in amendments to the law governing CSRS and make the funding of USPS retirement plans different from other federal agencies making annual contributions to the federal CSRS retirement plan. USPS makes these payments without any additional contributions from employee pay. In the Social Security Amendments of 1983 (P.L. 98-21), Congress mandated participation in Social Security by all civilian federal employees initially hired after December 31, 1983. Because Social Security provides both retirement and disability benefits, and because enrolling federal workers in both CSRS and Social Security would have resulted in employee contributions of more than 13 percent of each worker’s salary, Congress directed the development of a new federal employee retirement system with Social Security as the cornerstone. The result of these efforts was FERS, created by P.L. 99-335, enacted on June 6, 1986. All permanent federal employees, including USPS employees, whose initial federal employment began after December 31, 1983, are covered by FERS, as are employees who voluntarily switched from CSRS to FERS during specified “open seasons.” FERS consists of three elements: Social Security, a FERS annuity (a defined benefit plan), and a Thrift Savings Plan (TSP) (a defined contribution retirement savings and investment plan). The Service and its employees also contribute to Social Security and Medicare at the rates prescribed by law. In addition, USPS is required to contribute to TSP a minimum of 1 percent per year of basic pay for employees covered by FERS. The Service also matches voluntary employee contributions up to 3 percent of an employee’s basic pay, and 50 percent of a contribution from 3 to 5 percent of basic pay. In the legislation that created FERS, Congress also created the CSRS Offset Plan. Typically, CSRS Offset retirement applies to employees who had breaks in service that exceeded 1 year and ended after 1983 and had 5 years of creditable civilian service as of January 1, 1987. CSRS Offset retirement coverage also applies to employees hired before January 1, 1984, who acquired CSRS coverage for the first time after that date and had at least 5 years of creditable service by January 1, 1987. Under this plan, each employee and employer contribute an equal amount into Social Security, as prescribed by law. In retirement, these employees’ CSRS benefits are reduced (offset) by a portion of their Social Security benefits. Under the provisions of the CSRS Offset Plan, both USPS and the employee contribute a percentage of the employee’s basic pay to the CSRS fund, Social Security, and Medicare at the statutorily prescribed rates. To better understand the full nature and components of the Service’s retirement plans, we (1) interviewed officials at the Service and OPM, (2) reviewed and analyzed documents, including legislation, funding plans, budget documents, financial statements, USPS projections, and fiscal impact statements, and (3) analyzed the future projected costs of these plans. Our scope did not include identifying ways for the Service to respond to the current legal framework for funding its retirement liabilities to OPM for annual increases to CSRS basic pay and retiree COLAs. We conducted our work from May 2001 through October 2001 in accordance with generally accepted government auditing standards. We did not independently verify underlying data. We obtained oral comments from USPS and written comments from OPM on a draft of this report. OPM’s written comments are reprinted in appendix IV. The Service projects that the total annual retirement costs for the three plans, including installment payments for its additional liability for increases in pay and retiree COLAs under CSRS, will increase over the next 10 years from $8.5 billion in fiscal year 2000 to an estimated $14 billion in fiscal year 2010. The FERS portion of that total, including Social Security, is estimated to more than double from $4.1 billion in fiscal year 2000 to $9 billion in fiscal year 2010. See figure 1 for the total of all the retirement plans’ historical and projected annual costs, including the installment payments made by USPS for its additional obligation to OPM for increases in pay and retiree COLAs under CSRS. See appendix I for the dollar amounts of each plan’s cost, including payments for increases to CSRS employees’ basic pay and retirees’ COLAs. A discussion of the costs for each of the three individual plans follows. The cost of the CSRS retirement plan for fiscal year 2000 was $800 million, excluding the payments made toward the Service’s additional obligation to OPM. Although total pension costs for all three retirement plans are expected to increase significantly, USPS estimates that the cost for the standard, annual CSRS contributions will decrease in the future as current employees participating in the plan begin to retire. (See figure 2.) In addition to the standard, annual contributions to CSRS discussed above, the Service is responsible for paying additional amounts to CSRDF to fund the future costs of pay increases that USPS granted to its employees under terms in new labor contracts and the annual COLAs to retirees, which were prescribed by law. The provisions for USPS to make these additional contributions to OPM make the funding of the Service’s retirement plans for both pay increases and COLAs different from other federal agencies making annual contributions to the federal CSRS retirement plan. As described in more detail in a later section of this report, USPS makes annual installment payments to OPM toward its additional liability for CSRS employees’ pay increases and retirees’ COLAs. The total installment payment for these liabilities in fiscal year 2000 was $3.6 billion, which included $1.6 billion in interest charges and $2 billion in principal payments. The Service estimates that its annual payments for these liabilities will continue to be significant, increasing steadily through fiscal year 2010, then decreasing at some later point as the number of employees, retirees, and survivors under CSRS decreases. (See figure 3.) The cost of FERS for fiscal year 2000 was $4.1 billion. The Service estimates that the annual cost of FERS will more than double to approximately $9 billion by fiscal year 2010. The large increase in FERS costs is expected because new employees (those hired after January 1, 1984) are mostly only eligible to participate in FERS. (See figure 4.) As employees in CSRS retire, they will be replaced by employees participating in FERS. The employers’ standard, annual contributions toward FERS are higher than CSRS because FERS contributions are calculated by OPM on a stronger actuarial basis than CSRS contributions. FERS contributions are on a “dynamic” basis, which includes assumptions for future rates of inflation, future salary increases, and a provision for an assumed percentage rate of return on plan investments. Together, USPS contributions and employee withholdings are intended to fully fund the annual pension cost for employees covered under FERS over the employees’ working careers with the Service. The cost of this plan for fiscal year 2000 was $35 million. Although total pension costs for USPS are expected to increase significantly, it estimates that the standard, annual contributions to the CSRS Offset Plan will decrease in the future as current employees participating in the plan begin to retire. (See figure 5.) The plan became effective during fiscal year 1986, but it covered certain employees hired after 1983; consequently, amounts paid in fiscal years 1986 and 1987 by the Service represent the retroactive effect of those costs. The Service pays in full its standard, annual retirement payments to OPM under provisions of the laws governing all federal employees participating in CSRS, FERS, and the CSRS Offset Plan. In addition, the Service reported in its fiscal year 2000 audited financial statements an outstanding liability for future retirement benefits of $32.2 billion (excluding $16.5 billion of future related interest charges over 30 years) due to obligations that made the Service liable for pay increases that employees received under terms of new labor contracts and for COLAs to retirees, who retired on or after July 1, 1971, and their survivors, under the CSRS retirement plan. COLAs are based on the rate of inflation as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). As prescribed by law, all CSRS retirees and survivors receive yearly COLAs equal to the annual percentage change in the CPI-W. The Service’s total liability balance has generally been increasing each year, even though it has been making annual installment payments toward this retirement liability. (See figure 6.) The increase is occurring because the annual additions to the Service’s liability have generally been greater than the annual principal payments made under the installment payment provisions set forth by law. For instance, the Service’s fiscal year 2000 additional liability was $2.7 billion, while its required principal installment payment was $2 billion, plus interest of $1.6 billion. Figure 7 displays how the annual increases in the liability have cumulatively increased more rapidly than the annual accumulated principal payments. By law, whenever USPS increases a CSRS employee’s pay as a result of new labor union contracts, it is liable to OPM for the present value of additional future retirement benefits to be paid to the employee upon retirement as a result of the pay increase. When an increase in pay is authorized, OPM determines the Service’s present value of the retirement liability for the future retirement benefits that will result from the pay increase. The Service is required to pay for this incremental liability in 30 equal annual installments, with interest computed at the rate used in the most recent valuation of CSRS, with the first payment due at the end of the fiscal year in which an increase in pay becomes effective. The interest rate for calculating the present value of the incremental liability and for determining the amortization payments has been 5 percent for 29 years. According to OPM’s Office of the Actuary, the law prescribes that the calculation of the additional annual cost of retirement benefits due to increases in basic pay be made on the “static” basis, which assumes no future inflation and no future general schedule salary increases. OPM’s Board of Actuaries has recommended a 5-percent discount rate for the purpose of the static valuation. OPM does not make the calculations on a “dynamic” basis, which would include an assumed annual rate of inflation, future salary increases, and a provision for an assumed percentage rate of return on plan investments. For fiscal year 1972, the Service’s first fiscal year of operations, OPM determined that the additional liability for basic pay increases was approximately $1 billion. Under the 30-year installment arrangement, the Service paid $63 million toward that additional cost for fiscal year 1972, leaving an unpaid liability balance of $954 million to be paid for future years. In each subsequent year, additional liabilities were accrued as a result of pay increases in each of those years. Because the liabilities being added each year are also being paid off in 30-year installments, the overall liability for unpaid pension costs has grown dramatically, even though the Service has been making annual payments on the accumulating balance. Figure 8 shows the growth in the liability balance attributable to increases in CSRS employee pay. For fiscal year 1972 through fiscal year 1981, the liability balance grew from approximately $1 billion to $10.3 billion. During the next 10 fiscal years (1982 through 1991), the balance grew to $21.8 billion (a 112-percent increase), and in the latest 9 fiscal years (1992 through 2000), it grew to $25.9 billion (a 19-percent increase). As more of the current CSRS employees eligible for basic pay increases retire, future increases in the liability balance should level off and, eventually, the balance due for pay increases should start to decrease. However, this decrease will likely be accompanied by an increase in the growth of retiree COLA liabilities until the CSRS retiree group begins to diminish. In the 29 years from fiscal years 1972 through 2000, the OPM assessments for pay increases totaled $42.1 billion. During that same period, the Service paid $16.2 billion in principal payments toward that liability, plus interest of $21.6 billion, for total payments to OPM of $37.8 billion. As of September 30, 2000, the Service owed $25.9 billion in principal, and its annual principal payments have generally been less than the additional liabilities assessed each year. Because the Service is making principal payments in amounts less than the new liability added each year, the unpaid balance is growing, as is the interest charged annually on the unpaid balance. See appendix II for the annual liabilities added by OPM to the Service’s balance for CSRS pay increases and the annual installment payments made by the Service to OPM to reduce the liability balance. By law, the Service is also liable for its share of the COLAs granted to retirees who retired after July 1, 1971, and their survivors. As prescribed by law, CSRS retirees and survivors receive yearly COLAs. Each year, OPM determines the estimated increase in the Service’s liability for the COLA increase and establishes the amount of the installment payments to be made over a 15-year period, plus interest at 5 percent per year. Since fiscal year 1990, the Service has recorded a total liability of $11.1 billion for retiree COLA increases. Of that liability amount, the Service has paid OPM $4.8 billion, plus interest of $2.3 billion for a total of $7.1 billion. Because the Service is only required to pays a portion of the annual increase of this liability, its payments have generally been less than the additional liabilities added each year, and the balance, as well as the interest on the unpaid balance, continues to grow. Even with projections of low inflation, the Service expects the new annual liability amounts to be larger than its annual payments on the liability because the retiree/survivor population will increase. Thus, the total liability for retiree COLAs is expected to continue to grow over time until most of the CSRS annuitants are deceased. Figure 9 depicts the change in the liability amount. Also, see appendix III for the annual liabilities added by OPM to the Service’s liability balance for COLA increases and the annual installment payments made by the Service to OPM toward reducing the balance. Although not part of a retirement plan, the Post-Retirement Health Benefit Program is an additional benefit available to USPS retirees. The post- retirement health benefit represents a significant cost, which is also expected to increase in future years. USPS estimates that the annual cost of this benefit will increase from $744 million in fiscal year 2000 to about $2 billion in fiscal year 2010. In the Service’s Integrated Financial Plan for Fiscal Year 2002, health care costs are projected to increase by 10 percent; however, subsequent to that projection it was reported that the average premiums for employees will rise an average 13 percent in fiscal year 2002. These large, unexpected increases in health care costs make projections of future costs very uncertain. USPS is required to pay the employer’s share of health insurance premiums incurred through participation in the Federal Employees Health Benefit Program (FEHBP) for all employees who retired on or after July 1, 1971, and their survivors. The annual cost for this program is included in the Service’s Total Compensation and Benefits expense reported in its annual financial statements and disclosed separately in the footnotes to those statements. When the cost of the post-retirement health benefits of $744 million for fiscal year 2000 is added to the Service’s total retirement costs of $8.5 billion for fiscal year 2000, the total for retirement-related costs becomes $9.3 billion in fiscal year 2000. USPS projects that in fiscal year 2010, these total retirement-related costs will increase to $2 billion and $14 billion, respectively, for a total of $16 billion. The Service also projected that these costs, in fiscal years 2001 and 2002, would increase to $9.9 billion and $10.3 billion, an increase of $600 million and $400 million over the preceding year for each of those years, respectively. These increases exert upward pressure on postal rates and constrict cash flows needed for operating purposes. Many stakeholders are calling for a structural transformation of the Service because of the major financial, operational, human capital, and market competition challenges confronting it. Accordingly, in April 4, 2001, testimony before the House Committee on Government Reform, the Comptroller General announced that we had placed the Service’s transformational efforts and long-term outlook on our high-risk list. This focused needed attention on the challenges facing the Service. The Service responded by establishing a Transformation Plan Task Force on July 25, 2001. The task force will identify options to transform the Service so that it will be able to resolve the many challenges it faces in the future. As the Transformation Plan Task Force examines the impact of these retirement costs and liabilities on the Service’s overall financial condition and future operations, there are key questions that need to be addressed. Once the task force has analyzed these questions in detail, it can weigh various options and their long-term implications for the Service. Some of the specific questions that we see as being important include the following. What is the significance of USPS’ growing retirement-related obligations on various options that will be considered as part of its transformation? How would issues relating to retirement-related obligations be addressed if a specific option were to be chosen, such as transforming USPS into a government corporation or a publicly owned company? What is the impact of USPS retirement-related obligations, including retiree health care costs, on its overall financial condition, equity position, cash flows from operations, and ability to fund capital outlays that depend on positive cash flows? Also, what is the impact of the Service’s retirement-related obligations on the scope and quality of postal services that depend on the use of funds for continued modernization and maintenance of capital assets? What is the potential impact of growing retirement-related expenses on postal rates? Could this impact affect USPS’ ability to be successful in a marketplace with increasing competition from electronic alternatives, private delivery companies, and foreign postal administrations? Under current law, is USPS fully covering OPM’s future retirement costs for USPS employees, or is USPS paying more than is needed to cover OPM’s future payments to USPS retirees? Has OPM estimated the amount of future obligations to USPS retirees, and has OPM determined that USPS has contributed a sufficient amount, or, possibly, more than enough, toward plan assets that will pay USPS retirees? USPS provided oral comments that substantially agreed with our report. Matters of emphasis and points of clarity recommended by USPS have been reflected in this report, as appropriate. OPM provided written comments that are reprinted in appendix IV, along with our comments. We are sending copies of this report to the Chairmen and Ranking Minority Members of the House and Senate Committees on Appropriations, the Postmaster General, the Chairman of the Postal Board of Governors, the Chairman of the Postal Rate Commission, the Chief Financial Officer of the U.S. Postal Service, the Director of the Office of Personnel Management, and interested congressional committees. We will also provide copies to others on request. If you have any questions on this report, please contact me at (202) 512- 2600 or Jeanette M. Franzel, Acting Director, at (202) 512-9471. We can also be reached by e-mail at steinhoffj@gao.gov or franzelj@gao.gov, respectively. Joseph Applebaum, Senior Actuary, Michael Fischetti, Meg Mills, John Sawyer, and Fred Evans were key contributors to this report. FERS (including TSP) FERS (including TSP) The following are GAO’s comments on the Office of Personnel Management’s letter dated November 23, 2001. 1. The “fine tuning” items were not included in the report because the amounts were paid to OPM by fiscal year 1998 and are no longer outstanding liabilities of the Postal Service. 2. Our report has been revised to reflect that the Board of Actuaries of CSRS determined the 5-percent discount rate used in the amortization tables to calculate payments to be made to OPM. 3. Our Senior Actuary agreed with the OPM comment; therefore, we have deleted the sentence from our report.

Summary: This report identifies long-term structural or operational issues that may affect the U. S. Postal Services's (USPS) ability to provide affordable universal postal service on a break-even basis. One key issue is the Service's retirement costs and future liabilities. USPS had a net loss of $199 million in fiscal year 2000 and recently announced a $1.7 billion net loss for fiscal year 2001. The impact of September 11 and the subsequent anthrax mailings on the volume and the cost of future mail service is unclear. USPS' annual retirement plan costs are projected to rise significantly in the next 10 years--from $8.5 billion in fiscal year 2000 to $14 billion in fiscal year 2010. USPS also faces mounting debt because of pay increases resulting from new labor contracts and annual cost-of-living adjustments for retirees. USPS reported an outstanding liability for future retirement benefits of $32.2 billion as of September 2000, and anticipates paying another $16.5 billion in interest on this liability over 30 years. The Post-Retirement Health Benefit Program--an additional benefit available to USPS retirees--cost $744 million in fiscal year 2000. When this benefit is added to the retirement plan, it raises total retirement costs for fiscal year 2000 to $9.3 billion. USPS projects that this additional post-retirement health benefit will cost $2 billion in fiscal year 2010, raising the Service's total retirement costs to $16 billion that year.