March 7, 2006
JS-4098
Prepared Remarks
Assistant Secretary Mark J. Warshawsky
The DC Bar, Washington, DC
Introduction
As you know, both the House and Senate passed their versions of pension reform legislation at the end of 2005. As we wait for a House-Senate conference committee to convene, I believe this is an excellent opportunity to discuss the need for fundamental reform and to highlight some areas where the Administration believes the conference report must do better than either the House or Senate bills in order to ensure that pensions promises made are pension promises kept.
In addition to defined benefit reforms, I will discus
Defined Benefit Pension Reform
Clearly, the current system does not ensure that defined benefit pension plans -- whether single employer or multiemployer -- are adequately funded. While many companies act in good faith to fund their pensions, the law unfortunately allows employers to comply with pension rules technically without adequately funding the pension promises they make. When underfunded plans terminate, workers often lose significant pension benefits that they earned over a long career of service and upon which their retirement security depended. As a result, current systemic underfunding of defined benefit pensions represents an ongoing threat to the financial security of workers.
The termination of seriously underfunded plans also severely strains the pension insurance system and imposes burdens on the employers who sponsor healthy pension plans. The current net deficit of the PBGC is approximately $23 billion and, without meaningful pension reform, is expected to increase significantly. The PBGC's financial situation represents a serious and ongoing threat to the benefits of
The Administration does not believe that the defined benefit pension system can be sustained in the long run without meaningful reform. That is why we worked very hard over the past few years to write a plan to fundamentally reform the rules governing pension plan funding, disclosure and insurance premiums. Our plan, which was unveiled last year in the President's budget, is based on the following three simple principles:
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Ensuring pension promises are kept by improving opportunities, incentives and requirements for funding plans adequately;
- Improving disclosure to workers, investors and regulators about pension plan status; and
- Adjusting the pension insurance premiums to better reflect each plan's risk and to ensure the pension insurance system's financial solvency.
We are pleased that both the House and the Senate have taken action on this important problem by passing pension reform legislation, and we remain committed to working with Congress as they proceed to conference. Nevertheless, the Administration is concerned that the reforms currently being considered by Congress are inadequate and that stronger action is needed to improve the protection of pension benefits, to ensure the integrity of the pension insurance system, and to avert a taxpayer bailout. In the absence of changes to strengthen the legislation, workers will face an increased risk of losing pension benefits promised to them by their employers.
We plan on working productively with the conference committee to improve the final bill. As you may be aware, the Administration issued veto threats against both the House and Senate bills. We continue to have serious concerns and will insist on a bill that reduces the risk to workers. Currently, the best available measure of that risk is projections of future claims on the PBGC. We believe that any acceptable reform bill should reduce expected claims on the PBGC over the next ten years compared to current law. We hope to work with the conference committee to ensure that the final bill meets this goal.
Already, some structural similarities exist between the Administration proposal and the House and Senate bills. Congress included some of our key provisions, including those that
- Increase funding targets for pension plans to 100 percent of accrued liabilities;
- Reduce the period over which increases in pension underfunding can be amortized to no more than 7 years; and
- Require the use of a (modified) yield curve rather than a single long-term interest rate to compute pension liabilities and lump-sum distribution
These are all important changes.
In addition, the Administration is pleased that the Senate and House bills include provisions to provide workers with more information about the financial condition of their pension plans and to restrict plan sponsors with severely underfunded plans from making additional pension promises without paying for them. I believe these two provisions will have a significant, positive impact on ensuring that pension promises, once made, are kept and encouraging plan sponsors to responsibly fund their pension plans.
However, despite these structural similarities, there are significant differences between these bills and the Administration's proposal. These differences include:
- Overly long phase-in periods;
- Continued inaccurate measurement of pension assets and liabilities;
- The use of mortality tables that do not recognize expected future increases in longevity to compute pension liabilities;
- The lack of any effective mechanism to increase the funding requirements for pension plans with financially weak sponsoring firms;
- The continued use of credit balances; and
- The inclusion of industry-specific relief and administrative workout programs that will weaken the entire funding regime.
More specifically, we believe the conference report should not include the myriad transition rules that delay implementation of the full funding targets and the establishment of important restrictions on unfunded benefit increases. An effective date of the legislation to plan years beginning on or after
Moreover, we support limiting asset and liability smoothing to no longer than twelve months, as currently in the Senate bill. The seven year amortization period sufficiently limits contribution volatility, and plan sponsors can take additional steps to reduce contribution volatility, such as taking advantage of generous maximum deductible limits. It is inappropriate to reduce the accuracy of pension assets and liabilities measurement as a means of limiting contribution volatility. On this point, we are very concerned about provisions in both bills that would use discount factors drawn from the yield curve of investment-grade, corporate bonds. We have been very clear on this point – the appropriate credit quality for discounting pension liabilities and computing lump-sum payouts is high-quality, as opposed to merely investment-grade.
Mortality assumptions are also a critical component to accurate measurement of plan liabilities. The Administration believes that mortality tables used to measure plan liabilitie
To ensure the fair treatment of financially-strong sponsors of well-funded pension plans and to reduce losses to workers, it is essential that pension funding rules appropriately account for the risk that underfunded plans with financially-weak sponsors pose to the pension insurance system as a whole. For this reason, the Administration believes the conference report should include an effective and robust "at-risk" funding measure. PBGC modeling ha
This issue of credit balances is also an area of concern. Credit balances permit sponsors of underfunded plans to skip contributions despite the fact that their workers' retirement security remains at risk. The House and Senate bills each take steps to limit the use of credit balances, but the provisions are complex and continue to allow underfunded plans to use credit balances to take funding holidays. I hope that the final bill can go further toward eliminating or more severely restricting the use of credit balances. Credit balances are, at best, an inefficient means to encourage funding above the minimum and, at worst, a dangerous double counting of pension assets.
The Administration applauds the House's decision to not provide any targeted funding relief for airlines or other specific companies or industries and to reject special administrative workout programs. The Administration opposes these provisions because it is obvious that allowing underfunded plan sponsors to negotiate a separate regime of weaker funding rules with a government agency will weaken the incentives for plan sponsors to fund their pension promises adequately.
Multiemployer Defined Benefit Pension Reform
While much of the focus has been on single-employer plans, the Administration supports efforts to improve the funded status of multiemployer plans as well. However, we are concerned about provisions that would allow the extended override of the minimum funding rules in the most severely at-risk multiemployer plans. We believe that the funding improvement plan or rehabilitation plan should be in addition to minimum funding rules, thus ensuring that plan funding will improve relative to current law. There is a great deal of uncertainty about exactly how the multiemployer provisions will operate in practice, which is why I believe that adopting this "do no harm" approach is the prudent way to proceed. The Administration also suggests that a provision be included to require a mid-course review of the effectiveness of funding improvement and rehabilitation plans. This review should provide for the implementation of appropriate changes if these plans are not effective.
Defined Contribution Pension Reform
The current legislative agenda is not solely about defined benefit pensions. It is critical that we improve the regulatory structure around 401(k)-type defined contribution plans as they are increasing in popularity. The Center for Retirement Research at
Auto Enrollment
However, one potential concern related to AE is that the overall contribution rate is also affected; research suggests that a large majority of workers accept the default rate after automatic enrollment is implemented. In fact, some research suggests that the introduction of AE actually induce
While AE is not widely used, especially among small employers, recent survey
- Cost: When a plan introduces AE, it will expect to have greater employee participation and therefore pay more in matches to employees. Employers can, of course, change the terms of their plans, but doing so may run afoul of nondiscrimination safe harbors. The nondiscrimination rules are designed to ensure similar treatment of employees under tax preferred savings arrangements. The current rules offer safe harbor provisions for plans that meet minimum requirements in terms of plan generosity. The pension bills pending in Congress provide for a reduction in the minimum plan generosity to qualify for safe harbor status if using AE.
- State Laws: There are various state laws that prohibit AE; both the House and Senate pension bills preempt these laws.
- Investment Choices: There i
[1] Buessing, Marric and Mauricio Soto, The State of
Both the House and Senate bills include provisions aimed at overcoming these barriers. The Administration applauds these efforts and would like to see a conference report in which AE provisions apply to all workers and escalator provisions are included and applied broadly to the worker population, but with a minimum of complexity. In return, we feel that there can be a reasonable reduction in the non-discrimination safe harbor required matching contributions, a reasonable reduction in non-elective matching, and some increases in the vesting period, but less than the 2 years proposed in the House and Senate.
Other DC Reforms Provisions
In early 2002, the President proposed several other reforms to modernize and improve the defined contribution system. Congress has acted on some of these reforms already as part of the Sarbanes-Oxley legislation. However, there still three reforms outstanding. These reforms have been passed by the House on several occasions and are contained in the Senate version of the pension legislation. The House and Senate have approached these remaining three items in different ways.
- Increased Access to Investment Advice: Employer
- Freedom to Diversify Investments: Worker
- Better Information through Quarterly Benefits Statements: Workers need timely information about their 401(k) accounts. Under current law, employers are only required to make statements available to workers on an annual basis. We support a provision in the Senate bill that requires companies to provide participants with quarterly benefit statements with information about their individual accounts, including the value of their assets, their rights to diversify, and the importance of maintaining a diversified portfolio.
Permanent Extension of EGTRRA Provisions
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made many important changes to employer-provided retirement plans. For example, EGTRRA expanded the contribution limits for IRAs and retirement plans and created catch-up contributions for those age 50 and older, Roth 401(k) plans, and the Saver's credit, and provided incentives for small businesses to offer pension plans. The EGTRRA provisions will sunset in 2011, unless they are extended by Congress.
The House bill would permanently extend EGTRRA's retirement savings provisions – a step we certainly support. The Senate bill does not include provisions to extend the EGTRRA provisions.
Long-term care and the Life Care Annuity
Another important element of retirement security that the House pension reform bill addresses is the financing of long-term care expenses. Currently, Medicare and Medicaid pay for over half of nursing home and home health services for the Medicare population. With the impending Baby Boom retirement, this burden on federal and state governments is unsustainable.
As part of the recently enacted Deficit Reduction Act, Congress encouraged better planning for long-term care needs in retirement. Measures include restrictions on asset transfers for Medicaid qualification, limiting eligibility for Medicaid long-term care for people with substantial home equity, and allowing the state to become the residual claimant of large annuities for Medicaid long-term care beneficiaries.
The House pension bill builds on these reforms to encourage long-term care planning by clarifying the tax treatment of combined long-term care insurance policies and other insurance products, including annuities.
It is encouraging to see Congress explore ways to improve the market for long-term care insurance, an undeveloped market that will be crucial in improving long-term care financing. The risk of long-term care needs is certainly an insurable risk for people at or near retirement. Yet long-term care insurance pays for less than two percent of nursing home costs for the Medicare population. Encouraging innovation in the private long-term care insurance market would not only relieve the government of the burden of financing a majority of the long-term care expenses of the retiree population, but it would also save people from the risk of having to wipe out all their assets and go on Medicaid in the event of severe disability.
On that note, I'd like to talk about a product that I have had an interest in even before coming to the Treasury: the life care annuity. The life care annuity combines an immediate life annuity with the disability form of long-term care insurance--the kind of product that the House pension reform bill addresses. In return for a single premium, an insurance company would make steady periodic payments to a retired household (individual or couple), and would increase them substantially when a member of the household becomes disabled to the extent that he would require long-term care services.
Such a product could offer economic security for retirees by providing a steady stream of income combined with protection in the event of catastrophic costs associated with disability. The important innovation is that by linking the annuity with the long-term care insurance, we pool populations with two different risks: individuals who are likely to be long-lived and individuals who are in relatively poor health. This pooling allows the integrated product to be sold more cheaply than a comparable life annuity and long-term care insurance policy purchased separately. Another benefit is that the pooling of risks also allows most individuals who would not ordinarily pass underwriting for long-term care insurance to be eligible for the product, thus expanding the market.
While the long-term care insurance market is young, I believe the life care annuity could become an important element in financing the long-term care needs of certain elderly populations. Importantly, such an approach would reduce dependence on public programs like Medicaid, and would eventually work well as a distribution mechanism from qualified retirement plans and Social Security PRAs.
The House pension bill takes a couple of steps to make the life care annuity more marketable. First, it allows long-term care insurance policies to be considered tax-qualified when purchased as a rider on an annuity. This means that tax benefits given to certain long-term care policies will not be denied to policies purchased in conjunction with an annuity. Second, because annuities and long-term care policies are subject to different tax treatments, the investment in the annuity is reduced by the premium for the long-term care policy, and charges against the annuity for long-term care expenses are excluded from gross income. This allows the two parts of the policy to be treated, for income tax purposes, similar to stand-alone policies.
Conclusion
We have before us an historic opportunity to make fundamental improvements to worker's retirement security in the context of both the defined benefit and defined contribution systems. While the House and Senate pension reform bills do include many valuable provisions, we believe that more meaningful reforms are necessary. We look forward to working with the conference committee to make sure that the final legislative product ensures that pensions promises made are pension promises kept.