April 24, 2006
JS-4203
Prepared Remarks on Pension and Health Care Reforms
Assistant Secretary Mark J. Warshawsky
American Society of Pension Professionals & Actuaries
(ASPPA)
Washington, D.C.
Introduction
As you know, both the House and Senate passed their versions of pension reform legislation at the end of 2005 and a House-Senate conference committee was appointed earlier this year. As the conference committee reconvenes after the Easter break, 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:
- 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 in conference. Nevertheless, the Administration is concerned that the reforms currently being considered by Congress are inadequate and that stronger action is needed. 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.
Rifle shot Provisions
Moreover, I would be remiss if I did not highlight a glaring weakness in both of them. They are both laden with "rifle shot" provisions that provided targeted benefits to one firm or class of firms and workers. Exceptions from the rules reduce both the fairness and effectiveness of the system. These troubling provisions include:
- Provisions in the Senate bill that would allow airlines and airline catering companies a special lower measure of liability and a 20-year period to fund that liability. The Administration opposes these provisions because it is obvious that allowing some underfunded plan sponsors to have a separate regime of weaker funding rules will weaken the incentives for all plan sponsors to fund their pension promises adequately.
- Another provision in the Senate bill has an increase in PBGC guarantees for benefits for airline pilots. This provision is likely to cost PBGC hundreds of millions if not billions of dollars, and of course, will lead to calls to equal treatments for other professions and industries. This will significantly weaken PBGC finances and undermine the incentive to fund promised benefits.
- Yet another Senate provision that would delay the effective date until 2017 for rural electric cooperatives.
- And still another Senate provision that would delay the effective date until 2014 for a certain employer that has "rescued" another terminated plan with liability of $100-$150 million that was settled via assumption of the plan by another employer before
- Both House and Senate include special provisions to allow smaller contributions for interstate bus companies.
- The Senate bill also has three different expansions of the ability to transfer "surplus" pension assets to be used to provide retiree health benefits. We understand these provisions are designed to apply to three specific firms.
- The Senate bill has an exemption from the new multiemployer funding rules for a plan subject to PBGC agreement prior to
- The Senate bill has provision treating a defined benefit plan sponsored by a certain nonprofit organization as a governmental plan. We have been told this was designed for an individual hospital.
Put bluntly, these provisions have no place in a bill that should strengthen pension protections.
Another issue is the appropriate deductible limits. The Administration proposed a significant increase in the deductible limits to provide more than adequate opportunity for firms to pre-fund pension obligations. The proposal was to increase the limit to 130 percent of target liability plus normal cost and allow projection of compensation increases for flat dollar plans. Both the House and Senate have suggested even more generous limits. The limits proposed by the Administration were well thought out and based on analysis that suggested they were more than sufficient to allow adequate pre-funding. One natural compromise is to allow the greater of the original Administration proposal, which includes the salary increase and flat-benefit adjustments, and a higher percent of target liability, but without those upticks and adjustments.
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 and should put the system on a significantly improved path at the end of that period. We hope to work with the conference committee to ensure that the final bill meets these goals.
Defined Contribution Pension Reform
The current legislative agenda is not solely about defined benefit (DB) pensions. It is critical that we improve the regulatory structure around 401(k)-type defined contribution (DC) plans as they are increasing in popularity. The Center for Retirement Research at
[1] Buessing, Marric and Mauricio Soto, The State of
Auto Enrollment (AE)
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
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 two 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 acted on some of these reforms already as part of the Sarbanes-Oxley legislation. However, there are still three reforms outstanding. The House and Senate have approached these remaining 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.
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 allows. 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 an optional distribution mechanism from qualified retirement plans; if there were sufficient interest, the necessary changes to the minimum distribution requirements could be made to allow this form of distribution.
Health Care Reform and HSAs
I would like to devote the rest of my talk today to discussing the long-term challenges of health care cost growth and how the Administration is trying to confront them. Health care cost growth has been exceeding GDP growth by two percentage points annually since 1940. Health care spending currently stands at 16 percent of GDP, and it is predicted to come to 18.7 percent of GDP by 2014. Thus, the strain of high and rising health care costs on the government, employers, and on consumers is not projected to go away anytime soon. And if we do not begin to face these challenges, the strain on our society will eventually become far worse than anything we are seeing today. Over the next 75 years, the Medicare program is expected to cost taxpayers $29.7 trillion more than the revenue dedicated to it; that's 4.7 percent of the GDP over that time period. Thus, we have to begin to find ways to reduce the growth of unproductive health care spending while preserving the incentives for the health care sector to innovate to provide people with longer and healthier lives.
We are already witnessing one important consequence of rapidly rising health insurance costs in the continued erosion of the group health insurance market, particularly in the small group market. According to the Kaiser Family Foundation's annual survey, nearly 100 percent of firms with 200 or more workers offer health insurance to their employees, yet only 59 percent of firms with between 3 and 199 workers do, a drop of 9 percentage points from 2000. Rising health insurance costs and concerns about access are a significant public policy challenge. The experience of the early 1990s showed that the American public has little appetite for a wholesale overhaul of the health system to fix the gaps in insurance coverage. In addition, this Administration is very cognizant of the problems that ensue when the government crowds out the private sector. Therefore, the Administration is proposing a set of incremental reforms that will help restrain health care spending and help people get and maintain insurance coverage despite income, health, or employment shocks.
Many of the proposals are anchored in the expansion of health savings accounts, and because HSAs are a relatively new product innovation, I would like to explain a little about what these accounts are and why the Administration believes they hold promise.
Health savings accounts are accounts that individuals can contribute tax free to save for future medical expenses. Contributions can be made to them as long as you have an HSA-qualified high-deductible health plan, what I'll call an HDHP, a comprehensive health insurance policy with deductibles of at least $1,050 for self-only coverage and $2,100 for family coverage. Annual out-of-pocket expenses associated with the HDHP are limited to $5,250 for self-only coverage and $10,500 for family coverage. Annual contributions can currently be made up to the amount of the deductible. Withdrawals from the HSA can be made, tax free, at any time for qualified health expenses, which includes most out-of-pocket medical expenses. Thus, someone with an HDHP can contribute, every year, an amount equal to the deductible to his HSA and use those funds, which are exempt from income taxes, to meet the deductible. Any amount remaining in his HSA at the end of the year is rolled over to future years, to be used for future health care expenses.
The reason we believe these accounts should be encouraged is to correct the distortions created by the tax code that incent an inefficiently large amount of sometimes wasteful health care consumption, and to help people better plan for future health care needs.
The tax code encourages health insurance take-up by allowing employer contributions to insurance premiums to be excluded from taxable income. The combined income and payroll tax deductibility leads to discounts for health insurance of over 40 percent in some cases relative to other forms of consumption. The effect of this is to encourage over-insurance among the working population, so that people are encouraged to purchase insurance through their employers that has generous coverage and little cost-sharing.
This trend wipes out any notion of a market for routine or non-emergency health expenses. The "first-dollar" or close-to-it structure of employer provided coverage – a structure induced by rational responses to tax incentives - leads to over-consumption of health care. Because of the coverage, people make health care decisions without comparing the price of the good or service to the benefit they receive from it.
HSAs reduce the incentive to purchase overly generous health insurance by equalizing the tax treatment of out-of-pocket expenses and covered care. If routine or non-emergency expenses purchased out-of-pocket are taxed the same way routine expenses are under health insurance, then the demand for insurance coverage for those goods and services falls, and people will consume those services in a way that takes into account the price they pay and benefit they receive. HSAs still encourage insurance take-up, but they also discourage over-insurance that effectively removes market signals from the health care sector and inefficiently drives up the price of health care. Obviously, people may have concerns about whether individuals will stop getting needed care once they are in an HDHP. The famous
And because I have already spoken at length about the burdens associated with the rising cost of health insurance, I would like to bring up another characteristic of HSAs that often gets lost in discussions--that they actually encourage savings for future health care needs. Obviously, the funds in an HSA can be used to pay for health care consumed while enrolled in a health plan to meet the deductible or to pay for coinsurance. But after accumulating, they can serve as savings that may insulate an individual from the shock of losing employer-sponsored health insurance.
The uninsurance rate is twice for the unemployed than it is for the employed, and less than a quarter of the COBRA-eligible population takes up COBRA coverage. It's no surprise, with average family insurance premiums now exceeding $10,000 a year that someone without employment would forego health insurance. With health care consuming 16 percent of the economy, public policy is finally recognizing and addressing the shock of losing one's employer-sponsored health insurance subsidy by giving people an incentive to save for that possibility, because HSA-accumulated funds may be used to pay for COBRA premiums or for someone receiving unemployment insurance to pay for health insurance premiums on the individual market. Or, for that matter, to purchase long-term care insurance to insulate against post-retirement health shocks.
With the benefits of HSAs in mind, the Administration has crafted a set of proposals to further encourage HSA/HDHP participation. The Administration is proposing that the limit on annual HSA contributions be raised from the deductible to the policy's out-of-pocket maximum. Next, the Administration proposes full income tax deductibility of premiums on all HSA-qualified policies, whether the premiums are paid for by an employer or by an individual. These proposals are designed to encourage people to move into HSA-qualified plans, for the reasons I outlined above, and to encourage health insurance take-up by people without group insurance. This is important because millions of taxpayers have no access to health insurance through their employer. Small business owners are also not on equal footing with workers who get their insurance through the employer system.
A further expansion of deductibility being proposed by the Administration would allow for an income tax credit equivalent to the payroll tax on premiums for HSA-qualified plans and HSAs, whether the plan is purchased on the individual or group market. This, we hope, will make health insurance more affordable to the low-income populations -- groups that often have significant payroll tax liability but little income tax liability. Another proposal to help the low-income population has been in the President's budget for several years. It is a refundable tax credit to help low-income people purchase health insurance on the individual market. As structured in this year's budget, low-income families could get up to $3,000 in a refundable tax credit to purchase HSA-qualified insurance. If enacted, we believe the tax credits will be a significant help to low-income individuals who would otherwise be unable to afford health insurance.
Taken together, we expect these proposals to increase take-up of HDHP/HSA plans from a projected 14 million to 21 million by 2010. HDHPs can slow the growth of low-value health care; they will then help all of us to be able to afford the health care from which we benefit.
Conclusion
Obviously, we face short- and long-term challenges in financing retirement security and health care. 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. And we look forward to working with Congress as a whole in passing the Administration's health care agenda.