Before enactment of the Employee Retirement Income Security Act of 1974 (ERISA), few rules governed the funding of defined benefit pension plans, and participants had no guarantees that they would receive their promised benefits. Among other things, ERISA created the PBGC to protect the benefits of plan participants in the event that plan sponsors could not meet the benefit obligations under their plans. ERISA also established rules for funding defined benefit pension plans, instituted pension insurance premiums, promulgated certain fiduciary rules, and developed annual reporting requirements. When a plan is terminated with insufficient assets to pay its guaranteed benefits, PBGC takes over the plan and assumes responsibility for paying benefits to participants. According to PBGC’s 2004 annual report, PBGC provides insurance protection for over 29,000 single-employer pension plans, which cover 34.6 million workers, retirees, and their beneficiaries. PBGC receives no direct federal tax dollars to support the single-employer pension insurance program. Instead, 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 premiums paid by plan sponsors and income earned from the investment of program assets. Premiums have two components: a per participant charge paid by all sponsors (currently $19 per participant), and a variable-rate premium that some underfunded plans pay based on the level of unfunded benefits. The single-employer program has had an accumulated deficit—that is, program assets have been less than the present value of benefits and other obligations—for much of its existence. (See fig. 2.) In fiscal year 1996, the program had its first accumulated surplus, and by fiscal year 2000, the accumulated surplus had increased to about $10 billion, in 2002 dollars. However, the program’s finances reversed direction in 2001, and at the end of fiscal year 2002, its accumulated deficit was about $3.6 billion. In fiscal year 2004, the single-employer program incurred a net loss of $12.1 billion, and its accumulated deficit increased to $23.3 billion, up from $11.2 billion a year earlier. Furthermore, PBGC estimated that total underfunding in single-employer plans exceeded $450 billion, as of the end of fiscal year 2004. In defined benefit plans, formulas set by the employer determine employee benefits. DB plan formulas vary widely, but benefits are frequently based on participant earnings and years of service, and traditionally paid upon retirement as a lifetime annuity, or periodic payments until death. Because DB plans promise to make payments in the future, and because tax- qualified DB plans must be funded, employers must use present value calculations to estimate the current value of promised benefits. The calculations require making assumptions about factors that affect the amount and timing of benefit payments, such as an employee’s retirement age and expected mortality, and about the expected return on plan assets, expressed in the form of an interest rate. The present value of accrued benefits calculated using mandated assumptions is known as a plan’s current liability. Current liability provides an estimate of the amount of assets a plan needs today to pay for accrued benefits. ERISA and the Internal Revenue Code (IRC) prescribe rules regarding the assumptions that sponsors must use to measure plan liabilities and assets. While different assumptions will change a plan’s reported assets and liabilities, sponsors eventually must pay the amount of benefits promised; if the assumptions used to compute current liability differ from the plan’s actual experience, current liability will differ from the amount of assets actually needed to pay benefits. Funding rules generally presume that a pension plan and its sponsor are ongoing entities, and plans do not necessarily have to maintain an asset level equal to current liabilities every year. However, the funding rules include certain mechanisms that are intended to keep plans from becoming too underfunded. One such mechanism is the additional funding charge (AFC), which applies to plans with more than 100 participants. The AFC requires plan sponsors to make additional contributions to plans that fall below a prescribed funding level. With some exceptions, plans with reported asset values below 90 percent of current liabilities are affected by the AFC rules. A combination of recent events, long-term structural problems, and weaknesses in the legal framework governing the DB system has left PBGC with a significant long-term deficit and many large plans badly underfunded. Lower interest rates and equity prices since 2000 have combined to significantly increase pension underfunding through an increase in the present value of pension liabilities, and decreases in the value of pension plan assets. Meanwhile, intense cost competition as a result of globalization and deregulation has led to bankruptcies of plan sponsors in key industries like steel and airlines, and is exposing PBGC to the risk of significant future losses in these and other industries. This competitive restructuring has occurred simultaneously with a long term decline in defined benefit plan participation that threatens PBGC’s revenue base. In addition, the basic legal framework governing pension insurance and plan funding has failed to safeguard the benefit security of American workers and retirees and the PBGC’s financial condition. Too many companies are making pension promises that they are not required to deliver on, in part because of perverse incentives and “put options” created under the current pension insurance system. PBGC’s current premium structure does not properly reflect the risks to its insurance program and facilitates moral hazard by plan sponsors. Further, current pension funding rules have not provided sufficient incentives, transparency, and accountability mechanisms for plan sponsors to properly fund their benefit obligations and deliver on their promises. As a result, bankrupt plan sponsors, acting rationally and within the rules, have transferred the obligations of their large and significantly underfunded plans to PBGC. These weaknesses in the legal framework contribute to and are exacerbated by a lack of transparent information that makes it difficult for interested stakeholders to understand the true financial condition of and risk associated with selected pension plans. Over the last 5 years, many large pension plans have been adversely affected by simultaneous declines in broad equity indexes and long-term interest rates, as well as by the financial difficulties of their plan sponsors. Poor investment returns from stock market declines affected the asset values of pension plans to the extent that plans invested in stocks. According to the ERISA Industry Committee, assets in private sector defined benefit plans totaled $2.056 trillion at the end of 1999, dropped to $1.531 trillion at the end of 2002, and climbed back to $1.8 trillion by the end of 2004. Lower equity values since the end of 1999 have been particularly problematic because interest rates have also declined and thus increased the present value of plan liabilities. Some sponsors of large pension plans that were terminated were not in sufficiently strong financial condition to meet their pension funding requirements because of weaknesses in their primary business activities. Bankruptcies and pension plan terminations increased around the U.S. economic recession of 2001 and around prior recessions. These conditions played a part in increasing the unfunded liabilities of plans terminated by bankrupt sponsors since 2000. For example, according to the filing of its annual regulatory report for pension plans, Bethlehem Steel’s plan went from 86 percent funded in 1992 to 97 percent funded in 1999. From 1999 to its plan termination in December 2002, plan funding fell to less than 50 percent as assets decreased and liabilities increased and sponsor contributions were not sufficient to offset the changes. Long-term trends in some sectors of the economy and in defined benefit pension coverage are threatening both PBGC’s future solvency and the economic security in retirement of workers and retirees. PBGC’s risk of inheriting underfunded pensions largely stems from the fact that more than half of the pension participants it insures are in the manufacturing and airline sectors, which have been exposed to lower cost competition because of several factors including globalization and deregulation. A potentially exacerbating risk to PBGC is the cumulative effect of bankruptcy in these industries: if a critical mass of firms go bankrupt and terminate their underfunded pension plans, their competitors may also declare bankruptcy to similarly avoid the cost of funding their plans. PBGC also faces the possibility of long-term revenue declines from demographic changes in the population of defined benefit plan participants and a shrinking number of DB plans. Over the long term, an aging population of defined benefit plan participants threatens to reduce PBGC’s ability to raise premium revenues as participants die and are not replaced by enough new participants. The percentage of participants who are active workers has declined from 78 percent in 1980 to just under 50 percent in 2002. Furthermore, PBGC cannot effectively diversify its risk from the terminations of plans in declining economic sectors because companies in other growing industries have generally not sponsored new defined benefit plans. As plan sponsors in weak industries go bankrupt and terminate their pension plans, PBGC not only faces immediate changes in its financial position from taking over underfunded plans, but also faces losses of future revenues from these terminated plans. A related factor eroding PBGC’s premium base is the growth of lump-sum pension distributions. More and more plan participants are exiting the defined benefit system by taking lump-sum distributions from their plans. After a lump-sum distribution is paid, the participant is out of the defined benefit system and the plan sponsor no longer has to contribute to the pension insurance system on the participant’s behalf. In addition, lump- sum distributions to participants in underfunded plans can create the effect of a “run on the bank” and worsen a plan’s underfunding. In such cases, the plan may terminate without enough assets to pay full benefits to other participants and PBGC may incur losses. The increasing prevalence of lump-sum distributions in defined benefit plans and the growth of defined contribution plans also raise significant questions about whether many Americans will enjoy an economically secure retirement. Many Americans are at risk of outliving their retirement assets as life expectancies, health care, and long-term care costs continue to increase.