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July 15, 2003
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Good afternoon Chairman Johnson, Ranking Member Andrews, Chairman McCrery, Ranking Member McNulty, and Members of both Subcommittees. Thank you for inviting me to discuss the Administration’s proposal to improve the accuracy and transparency of pension information, as well as the funding of defined benefit pension plans. I am proud to represent the Department of Labor and the Employee Benefits Security Administration (EBSA), who work to protect American workers, retirees and their families and to support the growth and stability of our private pension and health benefits system.
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As you know, EBSA interprets and enforces Title I of the Employee Retirement Income Security Act (ERISA), which addresses the conduct of fiduciaries who are responsible for operating pension and health benefit plans. EBSA is charged with administering and enforcing this statute together with the Treasury Department, which is generally responsible for the tax provisions in ERISA, and the Pension Benefit Guaranty Corporation (PBGC), which provides insurance to protect the retirement benefits of participants in defined benefit plans when the corporate plan sponsor fails and the plan is inadequately funded.
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ERISA governs approximately 730,000 private pension plans and six million private health and welfare plans. These plans cover approximately 150 million workers and their dependents and hold assets of more than $4 trillion. There are approximately 33,000 defined benefit plans guaranteed by the PBGC covering 44 million workers and retirees.
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As my colleague from the Department of Treasury stated, the financial health of the voluntary defined benefit plan system is under significant pressure. Over the past two years, a significant number of large companies with highly underfunded defined benefit plans have failed, resulting in PBGC taking over their pension plan assets and liabilities. In FY 2002, the PBGC took a tremendous hit to its single-employer insurance program, going from a surplus of $7.7 billion to a deficit of $3.6 billion - a loss of $11.3 billion in just one year. The loss is more than five times larger than any previous one-year loss in the agency's 28-year history. Moreover, based on PBGC’s midyear unofficial unaudited financial report, the deficit has grown to approximately $5.4 billion.
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Why is the emergence of this deficit of such concern to Congress and the Administration? The PBGC’s alarming deficit reflects a fundamental imbalance in the system that has occurred not only because of historically low interest rates and a loss in asset values, but also because of structural weaknesses that allow certain plans to continue to over-promise benefits as they descend into insolvency. Defined benefit pension plans play an important role in retirement security and should remain a viable option for those companies and workers who desire them. Unless we correct the problems leading to underfunding, healthy plan sponsors who subsidize unhealthy companies through their premium payments will continue to drop out of the defined benefit system leaving only the sick plans behind - a classic insurance death spiral. The result will be fewer workers with defined benefit plans and a greater level of risk for those workers who remain covered. |
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When underfunded plans terminate without sufficient assets to pay promised benefits, many workers’ and retirees’ expectations are shattered, and, after a lifetime of work, they must change their retirement plans to reflect harsh realities. The Administration developed its reform package with these workers and retirees in mind. We can prevent similar situations in the future, while keeping a viable defined benefit system, if we act to improve and stabilize plan funding. If corporate plan sponsors and their counterparts in organized labor pursue reforms that leave pensions underfunded, then workers will remain vulnerable to losing some of the pension benefits they were promised. |
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PBGC and the Departments of Labor, Treasury, and Commerce have developed a reform package in an effort to improve pension security for workers and retirees by strengthening the financial health of the defined benefit system. Under Secretary Fisher has already discussed the Administration’s proposed discount rate for measuring pension plan liabilities, and I will now discuss the final two components of the Administration’s proposal regarding improved transparency of pension plan information and increased safeguards against pension underfunding. |
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It’s been said that sunlight is the best antiseptic. One of the hallmarks of the Bush Administration has been an aggressive agenda to strengthen our economy by improving transparency and moving corporate and union financial disclosures out of the shadows.
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America’s system of free enterprise, with all of its risks and rewards, is a great strength of our country and a model for the world. The fundamentals of a free market require clear rules and confidence in the accuracy of information if we are to achieve President Bush’s goal for “America to become an ownership society, a society where a lifetime of work becomes a retirement of independence.” Ownership involves risks, but that risk must be based on shared, accurate and timely information.
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As major investors, defined benefit pension plans sponsored by American companies play a critical role in our national economy and in the lives of American workers, retirees and their families. The financial health of these plans must be transparent and fully disclosed to their “owners” - the workers and their families who rely on promised benefits for a secure and dignified retirement.
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As columnist George Will said, a properly functioning free market system “requires transparency, meaning a sufficient stream of information - a torrent, really - of reliable information about the condition and conduct of corporations.” The same holds true for their pension plans. |
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While ERISA includes a number of reporting and disclosure provisions that provide workers with information about their employee benefits, there exists a void in the law when it comes to the disclosure of pension funding information to workers. For example, although workers have a right to expect that their pension plans are well funded and that their retirement benefits are secure, they are typically unaware that the law sets only minimum funding obligations. Workers often do not learn the true extent of their plan’s underfunded status until it terminates, frustrating workers’ expectations of receiving promised benefits - and a secure retirement. |
Current Law: The most basic disclosure requirement of a pension’s funding status to workers under current law is the summary annual report (SAR). ERISA(1) and DOL regulations require pension plans to furnish a SAR to all workers and retirees. The Form 5500, used by private sector pension and other employee benefit plans to annually report information to the Department of Labor, the Internal Revenue Service and the PBGC regarding the financial condition, investments and operations of their plans, is due seven months after the end of the plan year with a potential extension of an additional two and a half months. Following the filing deadline of the Form 5500, pension plan sponsors must then distribute the SAR within two months.
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Corporate pension plan sponsors must use a SAR to disclose certain basic financial information from the Form 5500 including the pension plan’s net asset value, expenses, income, contributions, and gains or losses. A pension plan’s net asset value is calculated based on the market value of assets minus the plan’s expenses incurred during the plan year. The SAR must also include the current value of a defined benefit plan’s assets as a percentage of its current liability if the percentage is less than 70 percent.
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The “current liability” is a plan's liability as of today, it is intended to reflect a pension plan’s liability assuming the employer’s plan will continue indefinitely. It does not reflect a plan’s “termination liability” - the cost to a company of terminating its pension plan by paying lump-sums and purchasing annuities in the private market that reflect the benefits workers have earned. This is an important distinction to workers concerned about the pension plan terminating.
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A second disclosure in current law is Section 4011 of ERISA that requires underfunded single-employer pension plans to send notices of their underfunding to workers and retirees. This notice must describe the plan's funding status and the limits of PBGC's guarantee. Generally, plans that are less than 90% funded on a current liability basis are required to distribute Section 4011 notices, although there are several significant exceptions.
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In 2002, preliminary data indicates that less than ten percent of plans gave notices as required by Section 4011 out of a universe of approximately 33,000 defined benefit pension plans. The notice must be furnished no later than two months after the filing deadline for the Form 5500 for the previous plan year, and may accompany the SAR if it’s in a separate document.
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ERISA requires some pension plans to provide a third type of disclosure under Section 4010, but these disclosures are not provided nor available to workers or the public. Section 4010 requires corporate pension plan sponsors with more than $50 million in aggregate plan underfunding to file annual financial and actuarial information with the PBGC. Filings are required no later than 105 days after the close of the filer's fiscal year, although PBGC may grant waivers and extensions.
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Pension plan sponsors who file Section 4010 data with the PBGC must provide identification, financial, and actuarial information. Plan sponsors must provide financial information including the company’s audited financial statement. Sponsors also are required to provide actuarial information that includes the market value of their pension plan’s assets, the value of the benefit liabilities on a termination basis, and a summary of the plan provisions for eligibility and benefits.
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In 2002, approximately 270 plan sponsors reported plan information with the PBGC under Section 4010. So far in 2003, approximately 350 plan sponsors have filed Section 4010 data. Prior to 2002, the largest number of Section 4010 filings received by the PBGC in any calendar year was less than 100. Obviously many more pension plans are triggering the $50 million level of underfunding that requires their sponsors to file Section 4010 data.
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Shortcomings of Current Law: The current disclosure rules have major shortcomings in both the timeliness and quality of the information made available. Current disclosures do not satisfy workers’, shareholders’ or the financial markets’ desire to understand the funding status of pension plans and the consequences of underfunding. The true measure of plan assets and liabilities is not transparent to workers, retirees, investors, or creditors.
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Pension plan sponsors calculate numerous measures of their pension plan liabilities, including current liability and actuarial liability, plus several methods of calculating each of them. Among all of these potentially confusing measures, only the termination liability comes close to expressing the pension plan’s true ability to pay promised benefits if it terminates, and the potential exposure to PBGC.
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Less than ten percent of pension plans sent workers and retirees notices of severe underfunding in 2002 as required by Section 4011. Although many plans are facing unprecedented levels of underfunding, the complicated rules and exceptions(2) in current law relieve most plans of the obligation to send Section 4011 notices.
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Even when plans are required to send Section 4011 notices, workers do not receive sufficient information regarding the consequences of plan termination. The information required does not reflect the plan’s underfunding on a termination basis: exactly the kind of information workers would most need if their pension plan is severely underfunded.
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In formulating our transparency proposal, the Administration recognized that workers and retirees deserve a better understanding of the financial condition of their pension plans, that required disclosures should realistically reflect funding of the pension plan on both a current and termination liability basis, and that better transparency will encourage companies to appropriately fund their plans.
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Disclose Plan Assets and Liabilities on a Termination Basis: The Administration proposes that all companies disclose the value of their defined benefit pension plan assets and liabilities on both a current liability and termination liability basis in their SAR. This straightforward reform proposal is sweeping and effective in that it would require all plans to report this information. Informed participants will better understand their plan’s funding status and plan accordingly. They can also serve as effective advocates encouraging their employers to better fund their plans.
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Disclose Funding Status of Severely Underfunded Plans: The Administration proposes that certain financial data already collected by the PBGC under Section 4010 from companies sponsoring pension plans with more than $50 million of underfunding should be made public. We propose that the available information be limited to the underfunded plan’s market value of assets, termination liability and termination funding ratios. Much of the information disclosed in the Section 4010 data, such as sensitive corporate financial information, should not be made public.
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As described earlier, Section 4010 liability data is more timely and of better quality than what is publicly available under current law. Year-end Section 4010 figures generally are required to be filed no later than 105 days after the close of the plan sponsor’s fiscal year. This information on the pension plans with the largest unfunded liabilities, currently restricted to the PBGC, is critical to workers, the financial markets and the public at large. Disclosing this information will both improve market efficiency and help encourage employers to appropriately fund their plans.
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Disclose Liabilities Based on Duration-Matched Yield Curve: The Administration also proposes that companies annually disclose their liabilities as measured by the proposed yield curve described by Under Secretary Fisher before the rate is fully phased in for funding purposes. Such disclosure will give workers and the financial markets more accurate expectations of a plan's funding obligations and status under the new liability measure.
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Before ERISA’s enactment in 1974, thousands of workers lost their pensions because their companies failed to adequately fund the benefits they promised. In enacting ERISA, Congress set out to ensure that companies would safely set aside enough money in advance to secure workers’ pensions. Unfortunately, current law does not achieve that goal.
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ERISA’s funding rules aim to provide both security for workers and flexibility for plan sponsors. However, existing rules do not prevent corporate sponsors from making pension promises that they cannot afford, nor require them to fund adequately the promises they make.
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Current Law: Current law establishes funding rules for pension plans, including rules that prohibit underfunded plans from increasing benefits. Under provisions in both the Internal Revenue Code and ERISA that apply to large plans,(3) if a pension plan's funding ratio falls below 60 percent of current liability, a company generally may not provide a benefit increase greater than $10 million unless the increase is immediately funded or security is provided to fully fund the improvement. A company sponsoring a plan with a funding ratio above 60 percent on a current liability basis may have a much lower funding ratio on a termination liability basis, exposing its workers to the risk of receiving reduced pension benefits from the PBGC if the plan terminates.
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Shortcomings in Current Law: Recent history demonstrates that some companies under financial duress make pension promises that in all probability will never be funded. These promises further strain the funding status of a plan and jeopardize the retirement security of unsuspecting workers when the plan ultimately terminates and is taken over by the PBGC. Furthermore, unfunded benefit increases undermine the financial integrity of the pension benefit guaranty system. Other defined benefit plan sponsors who fund their plans far more responsibly ultimately pay whatever unfunded benefits are guaranteed by PBGC through their premiums.
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The current system includes a “moral hazard.” A company facing financial ruin has the perverse incentive to underfund its defined benefit pension plan while continuing to promise additional pension benefits. The company, its employees, and any union officials representing them know that at least some of the additional benefits will be paid, if not by their own plan then by other plan sponsors in the form of PBGC guarantees. Financially strong companies, in contrast, have little incentive to make unrealistic benefit promises because they know that they must eventually fund them.
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The Administration believes we must ensure that companies, especially those in difficult financial straits, make benefit promises they can afford and fund the pension promises they make. As we develop more comprehensive funding reforms, we must stop the most financially challenged companies with severely underfunded plans from making pension promises that they cannot afford. Our proposal would only affect the most extreme examples of vulnerable plan sponsors, would help workers plan their retirements based on realistic benefit promises, and would minimize PBGC losses.
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The proposal that we provide to you now would require companies with below investment grade credit ratings whose plans are less than 50 percent funded on a termination basis to immediately fully fund or secure any new benefit improvements, benefit accruals or lump sum distributions. Benefit improvements would be prohibited unless the firm contributes cash or provides security to fully fund the improvement. The plan would be frozen, i.e., accruals (increases resulting from additional service, age or salary growth) would be prohibited unless the firm contributes cash or provides security to fully fund the additional liability.
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To prevent erosion of such plans’ funding, lump sum payouts of more than $5,000 would be prohibited unless fully funded or secured. Allowing workers to take lump sum distributions from severely underfunded plans, especially those sponsored by financially strapped companies, allows the first workers who request the distributions to drain the plan, often leaving the majority of workers to receive reduced payments from the PBGC when the plan terminates.
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The Administration also proposes to extend the above safeguards to plans of corporate plan sponsors that file for bankruptcy with plans funded at less than 50 percent of termination liability. Furthermore, we recommend that PBGC’s guaranty limits be frozen as of the date of the bankruptcy filing. This freeze would avoid another perverse incentive.
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Based on PBGC's preliminary 2003 data covering 90 percent of filing companies with plans that are underfunded by $50 million or more (the Section 4010 filers described above), only 57 plans sponsored by firms with below investment grade credit ratings are funded at or below 50 percent on a termination basis. Their liabilities total $34 billion but their assets total just $14 billion, leaving $20 billion of liabilities unfunded.
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Another 32 plans sponsored by unrated firms (which may be above or below investment grade) are funded at or below 50 percent. These plans report liabilities of $10 billion and assets of $4 billion. Still another 68 plans are sponsored by firms in bankruptcy. These plans report liabilities of $28 billion and assets of $14 billion.
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In Under Secretary Fisher’s testimony, he listed several of the areas under review for a package of more comprehensive reforms of the pension system. The issue of unfunded benefit increases by underfunded plans is prominent among those issues with which we have significant concerns. Our immediate proposal to restrict benefit increases by the most vulnerable plans and financially troubled companies does not represent everything that must be addressed in this area, but is merely a first step to “stop the bleeding” in cases that obviously undermine the financial integrity of the pension system.
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The President’s plan we’ve described today addresses only the most pressing issues Congress must address in the very short term. As Under Secretary Fisher noted, there are a host of other, extremely important, issues where we must work together to address if we are to restore workers’ and retirees’ confidence in their retirement plans and introduce a long-overdue measure of stability to the defined benefit pension system. |
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Defined benefit plans are intended to provide a secure source of retirement income that lasts a lifetime. Recent volatility in the stock market has reminded workers of the value of such plans where corporate plan sponsors bear investment risk. As our aging workforce begins to prepare for retirement and think about how to manage its savings wisely, there is a renewed interest in guaranteed annuity payouts that last a lifetime. |
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If we do nothing but paper over the problems facing defined benefit plans and the companies and unions that sponsor them, we will ill-serve America’s workers threatened by unfunded benefits and potentially broken promises. |
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The Bush Administration is continuing to work on further proposals to strengthen the defined benefit system. Our goal is to get plans on a path toward better funding, to reduce harmful volatility in contributions, to encourage companies to set funds aside during good times so that when we enter another tough economic patch, sufficient assets have been set aside to weather the storm. We must keep in mind that this is a voluntary system. By strengthening the rules to restore certainty in funding and prevent abuses, we will make it more attractive for plan sponsors to retain their defined benefit plans. |
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We are reviewing revised funding targets to protect workers from the threat of losing promised benefits because their plan terminates without sufficient assets to meet liabilities. We are reviewing revised funding rules that would better reflect the risk that a plan will terminate without sufficient assets. We are also reviewing the actuarial assumptions that underlie required funding contributions, including appropriate mortality tables, realistic retirement ages, and the frequency of lump sum payouts. And we intend to address some of the glaring gaps in the law, for example those that allow severely underfunded plans to continue to enjoy funding holidays because they are carrying credit balances based on outdated asset values. |
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We need to keep improving the system’s transparency, achieving better and more-timely disclosures to workers, retirees, and the financial markets. We also should re-examine the PBGC's premium structure to see whether it can better reflect the risk posed by various plans to the pension system as a whole. |
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As we have reviewed both the method of discounting and the need for comprehensive reforms, we have simultaneously recognized the need for some transition relief to employers in our early stages of economic recovery, while improving funding standards over the long term. But we cannot allow the acknowledged need to reduce some near-term pressures to delay comprehensive reforms for too long lest we put more workers’ retirement security at risk. |
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Finally, we need to look at the challenges facing the multiemployer pension system as well -- which has the same needs for transparency, accuracy of measurement, and adequate funding standards. |
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The reform package we unveiled last week was intended to respond to an immediate need to replace the expiring discount rate used to value plan liabilities. The limited nature of the package we are presenting at this time should in no way be construed as a signal that these are the only issues that should be addressed The Administration is not only ready but eager to work with Congress to develop a broad package of reforms that will strengthen the defined benefit system and protect the workers and retirees who rely on them for their retirement security. |
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Thank you and I will answer any questions the committees may have. |
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ERISA Section 104(b)(3)
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For example, many plans do not send out Section 4011 notices because the requirement does not apply to a plan if (1) the funded currently liability percentage for the plan year is at least 80 percent, and (2) such percentage for each of the two immediately preceding plan years (or each of the second and third years preceding plan years) is at least 90 percent. Notices are further not required under Section 4011 where plans do not pay a PBGC variable rate premium in a given plan year.
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Code section 401(a)(29) and ERISA section 307.
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