<DOC>
[109th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:99772.wais]
THE RETIREMENT SECURITY CRISIS: THE ADMINISTRATION'S PROPOSAL FOR
PENSION REFORM AND ITS IMPLICATIONS FOR WORKERS AND TAXPAYERS
=======================================================================
HEARING
before the
COMMITTEE ON EDUCATION
AND THE WORKFORCE
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
March 2, 2005
__________
Serial No. 109-3
__________
Printed for the use of the Committee on Education and the Workforce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
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______
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COMMITTEE ON EDUCATION AND THE WORKFORCE
JOHN A. BOEHNER, Ohio, Chairman
Thomas E. Petri, Wisconsin, Vice George Miller, California
Chairman Dale E. Kildee, Michigan
Howard P. ``Buck'' McKeon, Major R. Owens, New York
California Donald M. Payne, New Jersey
Michael N. Castle, Delaware Robert E. Andrews, New Jersey
Sam Johnson, Texas Robert C. Scott, Virginia
Mark E. Souder, Indiana Lynn C. Woolsey, California
Charlie Norwood, Georgia Ruben Hinojosa, Texas
Vernon J. Ehlers, Michigan Carolyn McCarthy, New York
Judy Biggert, Illinois John F. Tierney, Massachusetts
Todd Russell Platts, Pennsylvania Ron Kind, Wisconsin
Patrick J. Tiberi, Ohio Dennis J. Kucinich, Ohio
Ric Keller, Florida David Wu, Oregon
Tom Osborne, Nebraska Rush D. Holt, New Jersey
Joe Wilson, South Carolina Susan A. Davis, California
Jon C. Porter, Nevada Betty McCollum, Minnesota
John Kline, Minnesota Danny K. Davis, Illinois
Marilyn N. Musgrave, Colorado Raul M. Grijalva, Arizona
Bob Inglis, South Carolina Chris Van Hollen, Maryland
Cathy McMorris, Washington Tim Ryan, Ohio
Kenny Marchant, Texas Timothy H. Bishop, New York
Tom Price, Georgia John Barrow, Georgia
Luis G. Fortuno, Puerto Rico
Bobby Jindal, Louisiana
Charles W. Boustany, Jr., Louisiana
Virginia Foxx, North Carolina
Thelma D. Drake, Virginia
John R. ``Randy'' Kuhl, Jr., New
York
Paula Nowakowski, Staff Director
John Lawrence, Minority Staff Director
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C O N T E N T S
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Page
Hearing held on March 2, 2005.................................... 1
Statement of Members:
Boehner, Hon. John A., Chairman, Committee on Education and
the Workforce.............................................. 2
Miller, Hon. George, Ranking Member, Committee on Education
and the Workforce.......................................... 3
Norwood, Hon. Charlie, a Representative in Congress from the
State of Georgia, Prepared statement of.................... 93
Porter, Hon. Jon C., a Representative in Congress from the
State of Nevada, Prepared statement of..................... 93
Statement of Witnesses:
Belt, Bradley, Executive Director, Pension Benefit Guaranty
Corporation, Washington, DC................................ 6
Prepared statement of.................................... 8
Combs, Ann, Assistant Secretary of Labor, Employee Benefits
Security Administration, Washington, DC.................... 28
Prepared statement of.................................... 30
Mulvey, Janemarie, Ph.D., Chief Economist, Employment Policy
Foundation, Washington, DC................................. 76
Prepared statement of.................................... 77
Porter, Kenneth, Director of Corporate Insurance and Global
Benefits Financial Planning, The DuPont Company,
Wilmington, DE, on behalf of the American Benefits Council. 58
Prepared statement of.................................... 60
Stein, Norman, Douglas Arant Professor, University of Alabama
School of Law, Tuscaloosa, AL.............................. 68
Prepared statement of.................................... 70
Warshawsky, Mark, Assistant Secretary for Economic Policy,
U.S. Department of Treasury, Washington, DC................ 18
Prepared statement of.................................... 20
Additional materials supplied:
American Society of Pension Professionals & Actuaries,
statement submitted for the record......................... 102
ERISA Industry Committee, statement submitted for the record. 95
Food Marketing Institute, letter submitted for the record.... 106
Reuther, Alan, Legislative Director, International Union,
United Automobile, Aerospace & Agricultural Implement
Workers of America (UAW), statement submitted for the
record..................................................... 107
Society for Human Resource Management, statement submitted
for the record............................................. 94
THE RETIREMENT SECURITY CRISIS: THE ADMINISTRATION'S PROPOSAL FOR
PENSION REFORM AND ITS IMPLICATIONS FOR WORKERS AND TAXPAYERS
----------
Wednesday, March 2, 2005
U.S. House of Representatives
Committee on Education and the Workforce
Washington, DC
----------
The Committee met, pursuant to notice, at 10:06 a.m., in
room 2181, Rayburn House Office Building, Hon. John Boehner
(Chairman of the Committee) presiding.
Present: Representatives Boehner, Petri, Castle, Johnson,
Ehlers, Biggert, Tiberi, Osborne, Kline, Inglis, McMorris,
Price, Fortuno, Foxx, Drake, Kuhl, Miller, Kildee, Payne,
Andrews, Scott, Woolsey, Hinojosa, Tierney, Kucinich, Wu, Holt,
Davis, Grijalva, and Van Hollen.
Staff Present: Stacy Dion, Professional Staff Member; Kevin
Frank, Professional Staff Member; Ed Gilroy, Director of
Workforce Policy; Richard Hoar, Staff Assistant; Greg Maurer,
Coalitions Director; Jim Paretti, Workforce Policy Counsel;
Steve Perotta, Professional Staff Member; Molly McGlaughlin
Salmi, Deputy Director of Workforce Policy; Deborah L. Emerson
Samantar, Committee Clerk/Intern Coordinator; Todd Shriber,
Communications Assistant; Kevin Smith, Senior Communications
Advisor; Jody Calemine, Minority Counsel, Employer-Employee
Relations; Margo Hennigan, Minority Legislative Assistant/
Labor; Tom Kiley, Minority Press Secretary; John Lawrence,
Minority Staff Director; Michele Varnhagen, Minority Labor
Counsel/Coordinator; Daniel Weiss, Minority Special Assistant
to the Ranking Member; and Mark Zuckerman, Minority General
Counsel.
Chairman Boehner. The Committee on Education and the
Workforce will come to order.
We're holding this hearing today to hear testimony on the
retirement security crisis and the administration's proposal
for pension reform and its implications for workers and
taxpayers.
Under the Committee rules, opening statements are limited
to the Chairman and Ranking Member. If other Members have
opening statements, I ask unanimous consent to keep the hearing
record open for 14 days so Members can submit their statements.
Without objection, so ordered.
STATEMENT OF HON. JOHN A. BOEHNER, CHAIRMAN, COMMITTEE ON
EDUCATION AND THE WORKFORCE
I want to thank all of you for coming. I'm looking forward
to hearing from our witnesses today.
The impending retirement of the baby boom generation, along
with rising life expectancies and declining overall ratio of
workers to retirees, has made the issue of retirement security
a chief concern for our President, this Congress, and the
American people.
President Bush recognizes the retirement security of
American workers is more important than partisan politics.
That's why he has proposed action on a number of fronts to
strengthen worker retirement security, including proposals
designed not just to save Social Security, but also to ensure
the pension promises made to workers are kept.
While Social Security has received most of the attention,
our private pension system also needs significant reform.
It's clear that today's outdated and burdensome pension
laws have failed to protect the interests of workers, retirees,
and potentially, American taxpayers.
In fact, today's outdated rules actually encourage
employers to leave the system, and more and more are doing so
at an alarming rate. Without reform, more companies will
default on their plans or leave the defined benefit pension
system entirely.
This could surely require taxpayer intervention down the
road if the financial condition of the Pension Benefit Guaranty
Corporation continues to worsen.
We want to ensure that defined benefit plans remain viable
for workers, and to do, we need to reform and strengthen this
system.
We're entering a new kind of economy, with new kinds of
products, services, industries, and business models, and to
succeed in this knowledge-and-innovation-driven economy, we
need to be able to invest, and we can't do that if outdated
pension rules make it impossible for employers to adequately
budget for their pension costs from year to year.
So how do we bring our retirement security system, and
specifically our defined benefit pension system, into the 21st
century economy and encourage employers to continue to offer
their workers the best retirement benefits possible? And that's
the balance that we're trying to strike.
I'm pleased that the administration recognizes the urgent
need to strengthen the defined benefit system and has put forth
a comprehensive proposal for single employer reform.
As I've said before, the legislation we'll be introducing
in the upcoming weeks and months will not just tinker around
the edges of the defined benefit system and leave the most
difficult decisions to future generations. We expect that we
will have a comprehensive bill that will cover real reform of
this system.
It's critical that reforms be focused on our ultimate
goal--strengthening retirement security.
The urgency of the PBGC deficit is important, but our
efforts will not be focused solely on bolstering the PBGC. Our
reform efforts will be focused on reforming outdated rules to
improve pension funding, including implementing a permanent
method to appropriately calculate plan liabilities, provide
stability and predictability in pension funding, and enhance
disclosure for workers, especially those in troubled plans.
We're looking to strengthen the overall defined benefit
system, not force more employers to abandon their plans or
jeopardize the ability of an employee with a troubled plan to
recover and provide important benefits to their workers.
After reviewing the administration's proposal, I'm pleased
that many of the proposals are similar to the principles for
reform I outlined last September. We certainly share the same
goals and agree broadly on these principles for reform.
The hearing today will allow us to ask important questions,
examine how it would work in practice, and evaluate its impact
on pension plans, workers, employers, and the future of the
defined benefit system in general.
Our questions will focus on the administration's proposals
to reform the funding rules, increase employer premium, and
provide new disclosure for workers about the status of their
plans.
I note that the administration has not included any reforms
to the multi-employer system in its proposal and has chosen to
tackle that issue at a future time.
I believe worker pensions in the multi-employer system are
being left vulnerable not just because of funding losses over
the last several years, but because of structural problems that
need significant reform.
The seriousness of the problems within the multi-employer
pension system deserves our attention now, and that's why we
plan to address both single and multi-employer pension plans in
our upcoming legislative proposal.
I have no illusions about the kind of effort that this
project will require in this Congress. The short-term pension
bill replacing the thirty-year Treasury rate that Congress
enacted last year was supposed to be a simple, slam-dunk bill.
As you all know, it turned out to be 6 months of long and
tenuous negotiations.
Workers, retirees, and taxpayers are relying on us to move
quickly and get something accomplished on their behalf. We've
got a long year ahead oaf us, but we intend to move quickly.
I look forward to working with the administration as we
move forward with comprehensive reforms to strengthen worker
retirement security.
With that, I would like to yield to my colleague from
California, Mr. Miller.
STATEMENT OF HON. GEORGE MILLER, RANKING MEMBER, COMMITTEE ON
EDUCATION AND THE WORKFORCE
Mr. Miller. Thank you very much, Mr. Chairman. Thank you
for holding this hearing. It's a continuation of your efforts
to direct the resources of this Committee to strengthen
retirement security for millions of American workers.
I'm glad today that you mentioned that we would not just be
dealing with single employer, but also anticipate working on
the problems of the multi-employer plans also.
Security retirement security for millions of Americans is
an interest I think that all of us in Congress have, and it's a
task that we must meet and we must complete. Securing the
average American's retirement is one of the greatest challenges
facing this country and this Congress.
The three legs of the retirement platform--Social Security,
private pensions, and 401K savings plans--are each under
scrutiny, but for different reasons.
President Bush has argued that our cornerstone retirement
program, Social Security, is in a crisis and will not pay
benefits to younger workers. I and many others strongly agree
with his assessment--disagree, excuse me--disagree with his
assessment and with his proposal creating private accounts
within Social Security.
Social Security faces long-term challenges that must and
can be addressed. Meanwhile, however, the real crisis in
retirement has received far less attention--the weakness and
vulnerability of the traditional pensions and 401K savings
plans.
The fact is that Social Security, it can be argued, is the
most secure of all of our retirement plans in this country. It
covers 96 percent of all Americans and provides over 50 percent
of the retirement income for two-thirds of its retirees.
Social Security is funded through 2042 or 2052, and it will
continue to have sufficient revenues to pay 80 percent of its
promised benefits in perpetuity. No other retirement system in
the U.S., whether public or private, can make that kind of
promise.
The fact is, not a single company in the Fortune 500 can
say that its pension plan--with certainty, that its pension
plans--will be funded through 2052 or 2042, or that they can
pay 80 percent of all of their benefits in perpetuity.
Even in the best of times, defined benefit plans have never
covered more than 50 percent of the workforce and only provided
an average of about 20 percent of retirement income.
So we must look at how we must integrate the solutions to
all of these problems together.
And now the GAO has put the Pension Benefit Guaranty
Corporation on its watch list of high-risk programs for two
straight years because the pension insurer has a deficit of
over $23 billion and additional possible liabilities of $100
billion.
Meanwhile, total private sector pension under-funding has
soared to well over $450 billion.
401K plans are not doing much better. 401K plans have lost
over $60 billion since 2000. The median account balance is only
$14,000, hardly enough for even 1 year's retirement income.
The 401K assets are being managed by advisors with rampant
conflicts of interest who are eating up workers' hard-earned
retirement savings with excessive hidden fees, commissions, and
financial arrangements.
Our country's traditional enforcement and 401K retirement
systems need serious reform. I've been warning about these
danger signs for over 2 years. Now is the time for the action.
We must strengthen pension plans' funding and shore up the
PBGC.
I look forward to hearing the administration describe their
pension funding reform proposal today, but from what I've
learned so far, I'm concerned that the administration's
proposal is fairly harsh medicine and will likely further
endanger a very sick patient.
I believe we need to find ways to get most of the under-
funded pension plans to improve their funding over time, but I
am worried that the administration's proposal will push plans
out of the system, punish workers who do not control the
employer funding decisions.
It is one thing to make the plans that are more risky to
pay higher insurance premiums to reflect that risk. It is quite
another thing entirely, and is quite unfair, to force the
weakest plans to bear the burden of paying off PBGC's
accumulated deficit. Those costs should be shared among all
plans, not just the weakest ones.
PBGC's deficit is in large part because of the global
transformations in the steel, textile industries, and quite now
possibly the airline industries, and not by any actions of the
under-funded employers.
In that sense, I think the President's plan is a non-
starter and would likely do more harm than good to those plans.
We need to encourage the employees to stay in the defined
benefit plan, not push them out.
Finally, I hope that we will give employees and investors
access to up-to-date and accurate information about the
financial condition of their private pension plans. Current law
says that this must be kept secret.
I believe that is wrong, and I've introduced legislation to
make this information public. The President has agreed that it
should be made public, and I think the time is now to do that.
We need more transparency in this process for the employees and
the beneficiaries of these plans.
I look forward to hearing from today's witnesses and am
hopeful that the Committee will have full and fair discussions
on these issues.
Ms. Woolsey. Will the gentleman yield for one comment from
me?
Mr. Miller. Yes.
Ms. Woolsey. Thank you.
Mr. Miller. I guess I have time.
Ms. Woolsey. Thank you.
I'd just like to comment on the timeliness of this hearing
today.
In the news, Senator Frist was reported as saying that
Social Security reform will be put on the back burner for at
least a year, and that pension reform is now back on the radar
front and center.
Mr. Miller. I thank the gentlelady.
Chairman Boehner. We have two panels of distinguished--
Mr. Kucinich. Mr. Chairman, will any other Members of the
Committee be permitted to give statements?
Chairman Boehner. No. Under Committee rules, only the
Chairman and the Ranking Member.
Mr. Kucinich. OK.
Chairman Boehner. But any opening statement can be
submitted for the record.
I'd like to introduce our first panel of witnesses today.
Our first witness will be the Honorable Ann Combs, who is
the assistant secretary of the Employee Benefits Security
Administration, or EBSA, at the U.S. Department of Labor.
Before her appointment in May of 2001, Ms. Combs was vice
president and chief counsel for retirement and pension issues
for the American Council of Life Insurers.
She was also a principal at the William Mercer firm, and
also served on the Advisory Council on Social Security, and
well-known to most of us in this room.
Our second witness, the Honorable Mark Warshawsky, is the
assistant secretary for economic policy at the U.S. Department
of the Treasury.
Mr. Warshawsky serves as the Department of Treasury's top
economist and advises the Secretary and the deputy secretary on
a wide range of economic issues.
Specifically, his office is responsible for reporting on
current and prospective economic developments and assisting in
the determination of appropriate economic policies.
Previously, Mr. Warshawsky was director of research at
TIAA-CREF.
And our third witness today is Mr. Brad Belt. He is the
executive director of the Pension Benefit Guaranty Corporation.
As the chief executive officer of the corporation, Mr. Belt
is responsible for the PBGC's operations, including
administration of two insurance programs covering 31,000
defined benefit plans, plans that are sponsored by private
sector employers, providing annual benefit payments of more
than $3 billion to nearly one million workers and retirees, and
management of assets totaling some $40 billion.
I want to thank all of you for coming, and Ms. Combs, you
may begin.
Ms. Combs. Mr. Chairman, if the Committee will indulge us,
we had arranged our testimony, divided it up so that Brad Belt
would go first, followed by Assistant Secretary Mr. Warshawsky,
and I'm in the cleanup position.
Mr. Belt. I'm the table setter, Mr. Chairman. They're the
meat and potatoes.
Chairman Boehner. Mr. Belt, why don't you begin?
STATEMENT OF BRADLEY BELT, EXECUTIVE DIRECTOR, PENSION BENEFIT
GUARANTY CORPORATION, WASHINGTON, DC
Mr. Belt. Thank you, Mr. Chairman, Ranking Member Miller,
and Members of the Committee.
I comment you for your leadership on retirement security
issues, and I appreciate the opportunity to discuss the
challenges facing the pension insurance program.
My written testimony describes in detail the financial
status of the pension insurance program and the flaws in the
current funding rules that have led us to this point.
I would like to mention just a few key points that
highlight the need for the administration's reform proposal.
The first point is, we've already dug a fairly deep hole
and it could get much deeper if we do nothing.
PBGC ended the last fiscal year with an accumulated deficit
of just over $23 billion. That is a $30 billion swing in just 3
years, and the most recent snapshot taken by the PBGC finds
that corporate America's pension promises are under-funded by
more than $450 billion.
More important, $96 billion of this under-funding resides
in pension plans at greater risk of termination because the
sponsoring company has faced financial difficulties.
I would note, Mr. Chairman, that the risks of further
significant losses are not limited to the steel and airline
industries. The insurance program's $96 billion in reasonably
possible exposure spans a range of industries from
manufacturing, transportation, and communications to utilities,
wholesale, and retail trade.
It would also be a mistake to assume that these are merely
cyclical problems and that a return to the bull markets of the
1990's will save the day.
We cannot predict the future path of financial markets, and
even if we could, rising markets would not address the
underlying structural flaws in the pension system.
That leads to my second point, that the status quo rules
have led to this hearing.
Rather than encouraging strong funding and dampening
volatility, attributes like smoothing and credit balances have
been primary contributors to systemic under-funding.
The sad fact is that companies can comply with all of the
requirements of ERISA and the Internal Revenue Code and still
end up with plans that are well below 50 percent funded when
terminated.
The system is also rife with what economists call moral
hazard.
A properly designed insurance system has mechanisms for
encouraging responsible behavior and discouraging risky
behavior. The incentives in the pension insurance program,
however, run the other way.
In addition, the system suffers from a lack of
transparency. The current disclosure rules obfuscate economic
reality, shielding relevant information about the funded status
of pension plans from participants, investors, and even
regulators.
The third and most important point, Mr. Chairman, is that
this is not about the PBGC. It is about protecting the pensions
that millions of American workers have earned.
The termination of under-funded pension plans can have
harsh consequences for workers and retirees. When plans
terminate, workers' and retirees' expectations of a secure
future may be shattered, because by law, not all benefits
promised under a plan are guaranteed.
Other companies that sponsor defined benefit plans also pay
a price through higher premiums when under-funded plans
terminate. Not only will healthy companies be subsidizing weak
companies with chronically under-funded pension plans. They may
also face the prospect of having to compete against a rival
firm that has shifted a significant portion of its labor cost
onto the government.
In the worst case, PBGC's deficit could grow so large that
the premium increase necessary to close the gap would cause
responsible premium payers to exit the system. If this were to
occur, Congress would face pressure to have U.S. taxpayers pay
the benefits of workers whose pension plans have failed.
Mr. Chairman, the ultimate question that must be answered
is, who will pay for the pension promises that companies have
made to their workers? There are only four choices: the company
that made the pension promise; other companies, through higher
premiums; participants, through lower benefits; or taxpayers
through a rescue of the insurance fund.
The administration believes companies that make pension
promises should pay for their pension promises, and not shift
those costs to others.
Thank you for inviting me to testify, and I would be
pleased to answer any questions you may have.
[The prepared statement of Mr. Belt follows:]
Statement of Bradley D. Belt, Executive Director, Pension Benefit
Guaranty Corporation, Washington, DC
Mr. Chairman, Ranking Member Miller, and Members of the Committee:
Good morning. I want to commend you for your leadership on retirement
security issues, and I appreciate the opportunity to discuss the
challenges facing the defined benefit pension system and the pension
insurance program, and the Administration's proposals for meeting these
challenges.
My colleagues will describe the Administration's comprehensive
reform plan in detail, so I would like to take this opportunity to
briefly outline some of the reasons why fundamental and comprehensive
reform is so urgently needed if we are to stabilize the defined benefit
system, strengthen the insurance program, and protect the retirement
benefits earned by millions of American workers.
Introduction
Private-sector defined benefit plans are intended to be a source of
stable retirement income for more than 44 million American workers and
retirees. They are one of the crowning achievements of the system of
corporate benefit provision that began more than a century ago and
reached its apex in the decades immediately following World War II.
That system, however, has on occasion been beset by problems that
have undermined the economic security that workers and retirees have
counted on. For example, the bankruptcy of the Studebaker car company
in the early 1960s left thousands of workers without promised pension
benefits. In such cases Congress has been called upon to safeguard the
benefits workers were expecting indeed, Studebaker was the catalyzing
event that led to the passage of the Employee Retirement Income
Security Act (ERISA) and the creation of the Pension Benefit Guaranty
Corporation a decade later.
The defined benefit pension system is at another turning point
today, and the key issues are largely the same: Will companies honor
the promises they have made to their workers? The most recent snapshot
taken by the PBGC finds that corporate America's single-employer
pension promises are underfunded by more than $450 billion. Almost $100
billion of this underfunding is in pension plans sponsored by companies
that face their own financial difficulties, and where there is a
heightened risk of plan termination.
Of course, when the PBGC is forced to take over underfunded pension
plans, we will provide the pension benefits earned by workers and
retirees up to the maximum amounts established by Congress.
Unfortunately, notwithstanding the guarantee provided by the PBGC, when
plans terminate many workers and retirees are confronted with the fact
that they will not receive all the benefits they have been promised by
their employer, and upon which they have staked their retirement
security. In an increasing number of cases, participants lose benefits
that were earned but not guaranteed because of legal limits on what the
pension insurance program can pay. It is not unheard of for
participants to lose more than 50 percent of their promised monthly
benefit.
Other companies that sponsor defined benefit plans also pay a price
when underfunded plans terminate. Because the PBGC receives no federal
tax dollars and its obligations are not backed by the full faith and
credit of the United States, losses suffered by the insurance fund must
ultimately be covered by higher premiums. Not only will healthy
companies that are responsibly meeting their benefit obligations end up
making transfer payments to weak companies with chronically underfunded
pension plans, they may also face the prospect of having to compete
against a rival firm that has shifted a significant portion of its
labor costs onto the government.
In the worst case, PBGC's deficit could grow so large that the
premium increase necessary to close the gap would be unbearable to
responsible premium payers. \1\ If this were to occur, there
undoubtedly would be pressure on Congress to call upon U.S. taxpayers
to pay the guaranteed benefits of retirees and workers whose plans have
failed.
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\1\ See page 3, Pension Tension, Morgan Stanley, Aug. 27, 2004.
``[I]n today's environment healthy sponsors may well decide that they
don't want to foot the bill for weak plans' mistakes through increased
pension insurance premiums.''
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If we want to protect participants, premium payers and taxpayers,
we must ensure that pension plans are adequately funded over a
reasonable period of time. As I will discuss in more detail, the status
quo statutory and regulatory regime is inadequate to accomplish that
goal. We need comprehensive reform of the rules governing defined
benefit plans to protect the system's stakeholders.
State of the Defined Benefit System
Traditional defined benefit pension plans, based on years of
service and either final salary or a specified benefit formula, at one
time covered a significant portion of the workforce, providing a stable
source of retirement income to supplement Social Security. The number
of private sector defined benefit plans reached a peak of 112,000 in
the mid-1980s. At that time, about one-third of American workers were
covered by defined benefit plans.
[GRAPHIC] [TIFF OMITTED] T9772.010
In recent years, many employers have chosen not to adopt defined
benefit plans, and others have chosen to terminate their existing
defined benefit plans. From 1986 to 2004, 101,000 single-employer plans
with about 7.5 million participants terminated. In about 99,000 of
these terminations the plans had enough assets to purchase annuities in
the private sector to cover all benefits earned by workers and
retirees. In the remaining 2,000 cases companies with underfunded plans
shifted their pension liabilities to the PBGC.
Of the roughly 30,000 defined benefit plans that exist today, many
are in our oldest, most mature industries. These industries face
growing benefit costs due to an increasing number of retired workers.
Some of these sponsors also face challenges due to structural changes
in their industries and growing competition from both domestic and
foreign companies.
In contrast to the dramatic reduction in the total number of plans,
the total number of participants in PBGC-insured single-employer plans
has increased. In 1980, there were about 28 million covered
participants, and by 2004 this number had increased to about 35
million. But these numbers mask the downward trend in the defined
benefit system because they include not only active workers but also
retirees, surviving spouses, and separated vested participants. The
latter two categories reflect past coverage patterns in defined benefit
plans. A better forward-looking measure is the trend in the number of
active participants, who continue to accrue benefits. Here, the numbers
continue to decline.
In 1985, there were about 22 million active participants in single-
employer defined benefit plans. By 2002, the number had declined to 17
million. At the same time, the number of inactive participants has been
growing. In 1985, inactive participants accounted for only 28 percent
of total participants in single employer defined benefit plans, a
number that has grown to about 50 percent today. In a fully advance-
funded pension system, demographics don't matter. But when $450 billion
of underfunding must be spread over a declining base of active workers,
the challenges become apparent.
[GRAPHIC] [TIFF OMITTED] T9772.011
The decline in the number of plans offered and workers covered
doesn't tell the whole story of how changes in the defined benefit
system are impacting retirement income security. There are other
significant factors that can undermine the goal of a stable income
stream for aging workers.
For example, in lieu of outright termination, companies are
increasingly ``freezing'' plans. Surveys by pension consulting firms
show that a significant number of their clients have or are considering
instituting some form of plan freeze. \2\ Freezes not only eliminate
workers' ability to earn additional pension benefits but often serve as
a precursor to plan termination, which further erodes the premium base
of the pension insurance program.
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\2\ See, e.g., Aon Consulting, More Than 20% of Surveyed Plan
Sponsors Froze Plan Benefits or Will Do So, Oct. 2003; Hewitt
Associates, Survey Findings: Current Retirement Plan Challenges:
Employer Perspectives (Dec. 2003).
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Given the increasing mobility of the labor force, and the desire of
workers to have portable pension benefits that do not lock them into a
single employer, many companies have developed alternative benefit
structures, such as cash balance or pension equity plans that are
designed to meet these interests. The PBGC estimates that these types
of hybrid structures now cover 25 percent of participants. \3\
Unfortunately, as a result of a single federal court decision, the
legal status of these types of plans is in question, further
threatening the retirement security of millions of workers and
retirees. \4\
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\3\ Table S-35, PBGC Pension Insurance Data Book 2004 (to be issued
April 2005).
\4\ Cooper v. IBM Personal Pension Plan, 274 F. Supp. 2d 1010 (S.D.
Ill. 2003) (holding that cash balance plans violate age discrimination
provisions of ERISA). Other courts, however, have disagreed. Tootle v.
ARINC, Inc., 222 F.R.D. 88 (D. Md. 2004); Eaton v. Onan Corp., 117 F.
Supp. 2d 812 (S.D. Ind. 2000).
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The Role of the PBGC
The PBGC was established by ERISA to guarantee private-sector,
defined benefit pension plans. Indeed, the Corporation's two separate
insurance programs--for single-employer plans and multiemployer plans--
are the lone backstop for hundreds of billions of dollars in promised
but unfunded pension benefits. The PBGC is also the trustee of nearly
3,500 defined benefit plans that have failed since 1974. In this role,
it is a vital source of retirement income and security for more than 1
million Americans whose benefits would have been lost without PBGC's
protection, but who currently are receiving or are promised benefits
from the PBGC.
PBGC is one of the three so-called ``ERISA agencies'' with
jurisdiction over private pension plans. The other two agencies are the
Department of the Treasury (including the Internal Revenue Service) and
the Department of Labor's Employee Benefits Security Administration
(EBSA). Treasury and EBSA deal with both defined benefit plans and
defined contribution benefit plans, including 401(k) plans. PBGC deals
only with defined benefit plans and serves as a guarantor of benefits
as well as trustee for underfunded plans that terminate. PBGC is also
charged with administering and enforcing compliance with the provisions
of Title IV of ERISA, including monitoring of standard terminations of
fully funded plans.
PBGC is a wholly-owned federal government corporation with a three-
member Board of Directors--the Secretary of Labor, who is the Chair,
and the Secretaries of Commerce and Treasury.
Although PBGC is a government corporation, it receives no funds
from general tax revenues and its obligations are not backed by the
full faith and credit of the U.S. government. Operations are financed
by insurance premiums, assets from pension plans trusteed by PBGC,
investment income, and recoveries from the companies formerly
responsible for the trusteed plans (generally only pennies on the
dollar). The annual insurance premium for single-employer plans has two
parts: a flat-rate charge of $19 per participant, and a variable-rate
premium of 0.9 percent of the amount of a plan's unfunded vested
benefits, measured on a ``current liability'' \5\ basis.
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\5\ Current liability is a measure with no obvious relationship to
the amount of money needed to pay all benefit liabilities if a plan
terminates.
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The PBGC's statutory mandates are: 1) to encourage the continuation
and maintenance of voluntary private pension plans for the benefit of
participants; 2) to provide for the timely and uninterrupted payment of
pension benefits to participants; and 3) to maintain premiums at the
lowest level consistent with carrying out the agency's statutory
obligations. In addition, implicit in these duties and in the structure
of the insurance program is the duty to be self-financing.
See, e.g., ERISA Sec. 4002(g)(2) (the United States is not liable
for PBGC's debts).
These mandates are not always easy to reconcile. For example, the
PBGC is instructed to keep premiums as low as possible to encourage the
continuation of pension plans, but also to remain self-financing with
no recourse to general tax revenue. Similarly, the program should be
administered to protect plan participants, but without letting the
insurance fund suffer unreasonable increases in liability, which can
pit the interests of participants in a particular plan against the
interests of those in all plans the PBGC must insure. The PBGC strives
to achieve the appropriate balance among these competing
considerations, but it is inevitably the case that one set of
stakeholder interests is adversely affected whenever the PBGC takes
action. The principal manifestation of this conflict is when PBGC
determines that it must involuntarily terminate a pension plan to
protect the interests of the insurance program as a whole and the 44
million participants we cover, notwithstanding the fact that such an
action is likely to adversely affect the interests of participants in
the plan being terminated.
The pension insurance programs administered by the PBGC have come
under severe pressure in recent years due to an unprecedented wave of
pension plan terminations with substantial levels of underfunding. This
was starkly evident in 2004, as the PBGC's single-employer insurance
program posted its largest year-end shortfall in the agency's 30-year
history. Losses from completed and probable pension plan terminations
totaled $14.7 billion for the year, and the program ended the year with
a deficit of $23.3 billion. That is why the Government Accountability
Office has once again placed the PBGC's single employer insurance
program on its list of ``high risk'' government programs in need of
urgent attention.
[GRAPHIC] [TIFF OMITTED] T9772.012
Notwithstanding our record deficit, I want to make clear that the
PBGC has sufficient assets on hand to continue paying benefits for a
number of years. However, with $62 billion in liabilities and only $39
billion in assets as of the end of the past fiscal year, the single-
employer program lacks the resources to fully satisfy its benefit
obligations.
Mounting Pressures on the Pension Safety Net
In addition to the $23 billion shortfall already reflected on the
PBGC's balance sheet, the insurance program remains exposed to record
levels of underfunding in covered defined benefit plans. As recently as
December 31, 2000, total underfunding in the single-employer defined
benefit system came to less than $50 billion. Two years later, as a
result of a combination of factors, including declining interest rates
and equity values, ongoing benefit payment obligations and accrual of
liabilities, and minimal cash contributions into plans, total
underfunding exceeded $400 billion. \6\ As of September 30, 2004, we
estimate that total underfunding exceeds $450 billion, the largest
number ever recorded.
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\6\ See page 14, The Magic of Pension Accounting, Part III, David
Zion and Bill Carcache, Credit Suisse First Boston (Feb. 4, 2005).
``[F]rom 1999 to 2003 the pension plan assets grew by $10 billion, a
compound annual growth rate of less than 1%, while the pension
obligations grew by $430 billion, a compound annual growth rate of
roughly 10%.'' See also page 2, Pension Tension, Morgan Stanley (Aug.
27, 2004). ``DB sponsors were lulled into complacency by inappropriate
and opaque accounting rules, misleading advice from their actuaries
causing unrealistic return and mortality assumptions, and mismatched
funding of the liabilities, and the two decades of bull equity markets
through the 1990s veiled true funding needs.''
[GRAPHIC] [TIFF OMITTED] T9772.013
Not all of this underfunding poses a major risk to participants and
the pension insurance program. On the contrary, most companies that
sponsor defined benefit plans are financially healthy and should be
capable of meeting their pension obligations to their workers. At the
same time, the amount of underfunding in pension plans sponsored by
financially weaker employers has never been higher. As of the end of
fiscal year 2004, the PBGC estimated that non-investment-grade
companies sponsored pension plans with $96 billion in underfunding,
almost three times as large as the amount recorded at the end of fiscal
year 2002.
[GRAPHIC] [TIFF OMITTED] T9772.014
The most immediate threat to the pension insurance program stems
from the airline industry. Just last month, the PBGC became statutory
trustee for the remaining pension plans of US Airways, after assuming
the pilots' plan in March 2003. The $3 billion total claim against the
insurance program is the second largest in the history of the PBGC,
after Bethlehem Steel at $3.7 billion.
In addition, United Airlines is now in its 27th month of bankruptcy
and has argued in bankruptcy court that it must shed all four of its
pension plans to successfully reorganize. The PBGC estimates that
United's plans are underfunded by more than $8 billion, more than $6
billion of which would be guaranteed and a loss to the pension
insurance program.
Apart from the significant financial impact to the fund, if United
Airlines is able to emerge from bankruptcy free of its unfunded pension
liability, serious questions arise as to whether this would create a
domino effect with other so-called ``legacy'' carriers, similar to what
we experienced in the steel industry. Indeed, several industry analysts
have indicated that these remaining legacy carriers could not compete
effectively in such a case and several airlines executives have
publicly stated that they would feel competitive pressure to shift
their pension liabilities onto the government if United is successful
in doing so. Of course, these companies would first have to meet the
statutory criteria for distress terminations of their pension
obligations.
While the losses incurred by the pension insurance program to date
have been heavily concentrated in the steel and airline industries, it
is important to note that these two industries have not been the only
source of claims, nor are they the only industries posing future risk
of losses to the program.
The PBGC's best estimate of the total underfunding in plans
sponsored by companies with below-investment-grade credit ratings and
classified by the PBGC as ``reasonably possible'' of termination is $96
billion at the end of fiscal 2004, up from $35 billion just two years
earlier. The current exposure spans a range of industries, from
manufacturing, transportation and communications to utilities and
wholesale and retail trade. \7\ Some of the largest claims in the
history of the pension insurance program involved companies in
supposedly safe industries such as insurance ($529 million for the
parent of Kemper Insurance) and technology ($324 million for Polaroid).
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\7\ In a recent report, Credit Suisse First Boston finds that the
auto component and auto industry groups have the most exposure to their
defined benefit plans (even more so than airlines). The report notes
that ``these two industry groups stand out because, compared to others,
the degree of their pension plan underfunding is significant relative
to market capitalization.'' See page 60, The Magic of Pension
Accounting, Part III, David Zion and Bill Carcache, Credit Suisse First
Boston (Feb. 4, 2005).
[GRAPHIC] [TIFF OMITTED] T9772.015
Some have argued that current pension problems are cyclical and
will disappear on the assumption that equity returns and interest rates
will revert to historical norms. Perhaps this will happen, perhaps not.
The simple truth is that we cannot predict the future path of either
equity values or interest rates. It is not reasonable public policy to
base pension funding on the expectation that the unprecedented stock
market gains of the 1990s will repeat themselves. Similarly, it is not
reasonable public policy to base pension funding on the expectation
that interest rates will increase dramatically. \8\ The consensus
forecast predicted that long-term interest rates would have risen
sharply by now, yet they remain near 40-year lows. \9\ And, a recent
analysis by the investment management firm PIMCO finds that the
interest-rate exposure of defined benefit plans is at an alltime high,
with more than 90 percent of the exposure unhedged. \10\
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\8\ See page 1, Pension Update: Treading Water Against Currents of
Change, James F. Moore, PIMCO (Feb. 2005). ``Unfortunately things are
likely to get worse before they get better. . . As of the beginning of
February, the Moody's AA long term corporate index was below 5.50% and
30-year Treasuries were below 4.5%.''
\9\ Long-term rates have declined in Japan and Europe--to 2.5
percent and 4.0 percent, respectively--two economies facing the same
structural and demographic challenges as the United States. See page 1,
Pension Update: Treading Water Against Currents of Change, James F.
Moore, PIMCO (Feb. 2005).
\10\ See page 1, Defined Benefit Pension Plans' Interest Rate
Exposure at Record High, Seth Ruthen, PIMCO (Feb. 2005).
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More importantly, while rising equity values and interest rates
would certainly mitigate the substantial amount of current
underfunding, this would not address the underlying structural flaws in
the pension insurance system.
Structural Flaws in the Defined Benefit Pension System
The defined benefit pension system is beset with a series of
structural flaws that undermine benefit security for workers and
retirees and leave premium payers and taxpayers at risk of inheriting
the unfunded pension promises of failed companies. Only if these flaws
are addressed will safety and soundness be restored to defined benefit
plans.
Weaknesses in Funding Rules
The first structural flaw is a set of funding rules that are
needlessly complex and fail to ensure that pension plans are adequately
funded. Simply stated, the current funding rules do not require
sufficient pension contributions for those plans that are chronically
underfunded. Rather than encouraging strong funding and dampening
volatility as some have argued, aspects of current law such as
smoothing and credit balances have been primary contributors to the
substantial systemic underfunding we are experiencing. The unfortunate
fact is that companies that have complied with all of the funding
requirements of ERISA and the Internal Revenue Code still end up with
plans that are less than 50 percent funded when they are terminated.
Some of the problems with the funding rules include:
<bullet> The funding rules set funding targets too low. Employers
are not subject to the deficit reduction contribution rules when a plan
is funded at 90 percent of ``current liability,'' a measure with no
obvious relationship to the amount of money needed to pay all benefit
liabilities if the plan terminates. In addition, in some cases
employers can stop making contributions entirely because of the ``full
funding limitation.'' As a result, some companies say they are fully
funded when in fact they are substantially underfunded. \11\ Bethlehem
Steel's plan was 84 percent funded on a current liability basis, but
the plan turned out to be only 45 percent funded on a termination
basis, with a total shortfall of $4.3 billion. US Airways' pilots' plan
was 94 percent funded on a current liability basis, but the plan was
only 33 percent funded on a termination basis, with a $2.5 billion
shortfall. No wonder US Airways pilots were shocked to learn just how
much of their promised benefits would be lost.
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\11\ Generally, a plan's actuarial assumptions and methods can be
chosen so that the plan can meet the ``full-funding limitation'' if its
assets are at least 90 percent of current liability. Being at the full-
funding limitation, however, is not the same as being ``fully funded''
for either current liability or termination liability. As a result,
companies may say they are fully funded when in fact they are
substantially underfunded. This weakness in the current funding rules
is exacerbated by premium rules that exempt plans from paying the
Variable Rate Premium (VRP) if they are at the full funding limit. As a
result a plan can be substantially underfunded and still pay no VRP.
Despite substantial underfunding, in 2003 only about 17 percent of
participants were in plans that paid the VRP.
[GRAPHIC] [TIFF OMITTED] T9772.016
[GRAPHIC] [TIFF OMITTED] T9772.017
<bullet> The funding rules allow contribution holidays even for
seriously underfunded plans. Bethlehem Steel made no cash contributions
to its plan for three years prior to termination, and US Airways made
no cash contributions to its pilots' plan for four years before
termination. One reason for contribution holidays is that companies
build up a ``credit balance'' for contributions above the minimum
required amount. They can then treat the credit balance as a payment of
future required contributions, even if the assets in which the extra
contributions were invested have lost much of their value. Indeed, some
companies have avoided making cash contributions for several years
through the use of credit balances, heedlessly ignoring the substantial
contributions that may be required when the balances are used up.
<bullet> The funding rules rely on the actuarial value of plan
assets to smooth plan contribution requirements. However, the actuarial
value may differ significantly from the fair market value. Actuarial
value is determined under a formula that ``smooths'' fluctuations in
market value by averaging the value over a number of years. The use of
a smoothed actuarial value of assets distorts the funded status of a
plan. \12\ Masking current market conditions is neither a good nor a
necessary way to avoid volatility in funding contributions. Using fair
market value of assets would provide a more accurate view of a plan's
funded status. I would also note that the smoothing mechanisms in ERISA
and financial accounting standards are anomalies--airlines are not
allowed to smooth fuel costs; auto companies are not allowed to smooth
steel prices; global financial firms are not allowed to smooth currency
fluctuations.
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\12\ Page 72, The Magic of Pension Accounting, Part III, David Zion
and Bill Carcache, Credit Suisse First Boston (Feb. 7, 2005).
``Volatility is not necessarily a bad thing, unless it's hidden. . . .
Volatility is a fact of doing business; financial statements that don't
reflect that volatility are misleading.''
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<bullet> The funding rules do not reflect the risk of loss to
participants and premium payers. The same funding rules apply
regardless of a company's financial health, but a PBGC analysis found
that nearly 90 percent of the companies representing large claims
against the insurance system had junk-bond credit ratings for 10 years
prior to termination.
<bullet> The funding rules set maximum deductible contributions
too low. As a result, it can be difficult for companies to build up an
adequate surplus in good economic times to provide a cushion for bad
times. (However, this was not a significant issue in the 1990s--a PBGC
analysis found that 70 percent of plan sponsors contributed less than
the maximum deductible amount.)
Moral Hazard
A second structural flaw is what economists refer to as ``moral
hazard.'' A properly designed insurance system has various mechanisms
for encouraging responsible behavior that will lessen the likelihood of
incurring a loss and discouraging risky behavior that heightens the
prospects of claims. That is why banks have risk-based capital
standards, why drivers with poor driving records face higher premiums,
why smokers pay more for life insurance than non-smokers, and why
homeowners with smoke detectors get lower rates than those without.
However, a poorly designed system can be gamed. A weak company will
have incentives to make generous but unfunded pension promises rather
than increase wages. Plan sponsors must not make pension promises that
they cannot or will not keep. For example, under current law benefits
can be increased as long as the plan is at least 60 percent funded. In
too many cases, management and workers in financially troubled
companies may agree to increase pensions in lieu of larger wage
increases. The cost of wage increases is immediate, while the cost of
pension increases can be deferred for up to 30 years.
Or, labor may choose to bargain for wages or other benefits rather
than for full funding of a plan because of the federal backstop. \13\
If the company recovers, it may be able to afford the increased
benefits. If not, the costs of the insured portion of the increased
benefits are shifted to other companies through the insurance fund.
Similarly, a company with an underfunded plan may increase asset risk
to try to make up the gap, with much of the upside gain benefiting
shareholders and much of the downside risk being shifted to other
premium payers.
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\13\ See page 3, The Most Glorious Story of Failure in the
Business, James A. Wooten, 49 Buffalo Law Rev. 683 (Spring/Summer
2001). ``Termination insurance would shift default risk away from union
members and make it unnecessary for the UAW to bargain for full
funding.''
---------------------------------------------------------------------------
Unfortunately, the pension insurance program lacks basic checks and
balances. PBGC provides mandatory insurance of catastrophic risk.
Unlike most private insurers, the PBGC cannot apply traditional risk-
based insurance underwriting methods. Plan sponsors face no penalties
regardless of the risk they impose on the system. As a result, there
has been a tremendous amount of cost shifting from financially troubled
companies with underfunded plans to healthy companies with well-funded
plans.
Consider: Bethlehem Steel presented a claim of $3.7 billion after
having paid roughly $60 million in premiums over the 10-year period
1994 to 2003, despite the fact that the company was a deteriorating
credit risk and its plans were substantially underfunded for several
years prior to the time the PBGC had to step in. Similarly, while
United's credit rating has been junk bond status and its pensions
underfunded by more than $5 billion on a termination basis since at
least 2000, it has paid just $75 million in premiums to the insurance
program over the 10-year period 1995 to 2004. Yet the termination of
United's plans would result in a loss to the fund of more than $6
billion.
PBGC cannot control its revenues and cannot control most of its
expenses. Congress sets PBGC's premiums, ERISA mandates mandatory
coverage for all defined benefit plans whether they pay premiums or
not, and companies sponsoring insured pension plans can transfer their
unfunded liability to PBGC as long as they meet the statutory criteria.
Not surprisingly, PBGC's premiums have not kept pace with the
growth in claims or pension underfunding. The flat rate premium has not
been increased in 14 years. And as long as plans are at the ``full
funding limit,'' which generally means 90 percent of current liability,
they do not have to pay the variable-rate premium. That is why some of
the companies that saddled the insurance fund with its largest claims
ever paid no variable-rate premium for years prior to termination. In
fact, less than 20 percent of participants are in plans that pay a VRP.
Transparency
A third flaw is the lack of information available to stakeholders
in the system. The funding and disclosure rules seem intended to
obfuscate economic reality. That is certainly their effect--to shield
relevant information regarding the funding status of plans from
participants, investors and even regulators. This results from the
combination of stale, contradictory, and often misleading information
required under ERISA. For example, the principal governmental source of
information about the 30,000 private sector single-employer defined
benefit plans is the Form 5500. Because ERISA provides for a
significant lapse of time between the end of a plan year and the time
when the Form 5500 must be filed, when PBGC receives the complete
documents the information is typically two and a half years old. It is
exceedingly difficult to make informed business and policy decisions
based on such dated information, given the dynamic and volatile nature
of markets.
The PBGC does receive more timely information regarding a limited
number of underfunded plans that pose the greatest threat to the
system, but the statute requires that this information not be made
publicly available. This makes no sense. Basic data regarding the
funded status of a pension plan, changes in assets and liabilities, and
the amount that participants would stand to lose at termination are
vitally important to participants. Investors in companies that sponsor
the plans also need relevant and timely information about the funded
status of its pensions on a firm's earnings capacity and capital
structure. While recent accounting changes are a step in the right
direction, more can and should be done to provide better information to
regulatory bodies and the other stakeholders in the defined benefit
system.
Congress added new requirements in 1994 expanding disclosure to
participants in certain limited circumstances, but our experience tells
us these disclosures are not adequate. The notices to participants do
not provide sufficient funding information to inform workers of the
consequences of plan termination. Currently, only participants in plans
below a certain funding threshold receive annual notices of the funding
status of their plans, and the information provided does not reflect
what the underfunding likely would be if the plan terminated. Workers
in many of the plans we trustee are surprised when they learn that
their plans are underfunded. They are also surprised to find that
PBGC's guarantee does not cover certain benefits, including certain
early retirement benefits.
Finally, the Corporation's ability to protect the interests of plan
participants and premium payers is extremely limited, especially when a
plan sponsor enters bankruptcy. Currently, the agency has few tools at
its disposal other than plan termination. While PBGC has successfully
used the threat of plan termination to prevent instances of abuse of
the pension insurance program, it is a very blunt instrument. Plan
termination should be a last resort, as it means that participants will
no longer accrue benefits (and may lose benefits that have been
promised) and the insurance programs takes on losses that might have
been avoidable.
Conclusion
Companies that sponsor pension plans have a responsibility to live
up to the promises they have made to their workers and retirees. Yet
under current law, financially troubled companies have shortchanged
their pension promises by nearly $100 billion, putting workers,
responsible companies and taxpayers at risk. As United Airlines noted
in a recent bankruptcy court filing, ``the Company has done everything
required by law \14\ to fund its pension plans, which are underfunded
by more than $8 billion.
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\14\ Page 26, United Air Lines' Informational Brief Regarding Its
Pension Plans, in the US Bankruptcy Court for the Northern District of
Illinois, Eastern Division (Sept. 23, 2004).
---------------------------------------------------------------------------
That, Mr. Chairman, is precisely why the rules governing defined
benefit plans are in need of reform. At stake is the viability of one
of the principal means of predictable retirement income for millions of
Americans. The time to act is now. Thank you for inviting me to
testify. I will be pleased to answer any questions.
______
Chairman Boehner. Thank you.
Mr. Warshawsky.
STATEMENT OF MARK WARSHAWSKY, ASSISTANT SECRETARY FOR ECONOMIC
POLICY, U.S. DEPARTMENT OF THE TREASURY, WASHINGTON, DC
Mr. Warshawsky. Good morning, Chairman Boehner, Ranking
Member Miller, and Members of the Committee. I appreciate the
opportunity to participate in this hearing to discuss the
administration's proposal to reform and strengthen the single-
employer defined benefit pension system.
The primary goal of any pension reform effort should be to
ensure that retirees and workers receive the pension benefits
that they have been promised and earned. Clearly, the current
funding rules have failed to meet this goal.
As part of its reform proposal, the administration has
designed a new set of funding rules that we think will ensure
that participants will receive the benefits they have earned
from their pension plans.
Today, I'll briefly discuss a few critical issues
pertaining to these funding rules, while my colleague, Ann
Combs, will discuss the other elements of the proposal.
For any set of funding rules to function well, assets and
liabilities must be measured accurately. The system of
smoothing embodied in current law serves only to mask the true
financial condition of pension plans and to shift the risk of
unfunded liabilities from firms that sponsor under-funded plans
to plan participants and other sponsors in the insurance
system.
Under our proposal, assets will be marked to market;
liabilities will be measured using a current spot yield curve
that takes account of the timing of future benefit payments
summed across all plan participants.
Discounting future benefit cash-flows using the rates from
the spot yield curve is the most accurate way to measure a
plan's liability, liabilities computed using the yield curve
matched to the timing of obligations with discount rates of
appropriate maturities.
Proper matching of discount rates and obligations is the
most accurate way to measure today's cost of meeting pension
obligations.
Use of the yield curve is a prudent and common practice.
Yield curves are regularly used in valuing other financial
instruments and obligations, including mortgages, certificates
of deposit, and so on.
The administration recognizes that the current minimum
funding rules have contributed to funding volatility.
Particular problem areas are the deficit reduction contribution
mechanism and the limits on tax deductibility of contributions.
Our proposal is designed to remedy these issues by giving
the plans the tools needed to smooth contributions over the
business cycle.
These tools include increasing the deductible and
contribution limit that will give plan sponsors additional
ability to fund during good times, increasing the amortization
period for funding deficits to 7 years compared to a period as
short as 4 years under current law, and the freedom plans
already have to choose prudent pension fund investments.
Plan sponsors may choose to limit volatility by choosing an
asset allocation strategy or a conservative funding level so
that financial market changes will not result in large
increases in minimum contributions.
We believe these are the appropriate methods for dealing
with risk. It is inappropriate to limit contribution volatility
by transferring risk to plan participants and the PBGC.
Under our proposal, plan funding targets for healthy plan
sponsors will be established at a level that reflects the full
value of benefits earned to date under the assumption that plan
participant behavior remains largely consistent with past
history of an ongoing concern.
Plans sponsored by firms with below-investment-grade credit
will be required to fund to a higher standard that reflects the
increased risk that these plans will terminate.
Pension plans sponsored by firms with poor credit ratings
post the greatest risk of default. It is only natural that
pension plans with sponsors that fall into this readily
observable, high-risk category should have more stringent
funding standards.
Credit ratings are used throughout the economy and in many
government regulations to measure the risk that a firm will
default on its financial obligations. A prudent system of
pension regulation insurance would be lacking if it did not use
this information.
Credit balances are created when a plan makes a
contribution that is greater than the required minimum. Under
current law, a credit balance plus an assumed rate of return
can be used to offset future contributions.
We see two problems with this system.
First, the assets that underlie credit balances may lose,
rather than gain value.
Second, and far more important, credit balances allow plans
that are seriously under-funded to take funding holidays.
In our view, every under-funded plan should make minimum
annual contributions, and under our proposal they will do so,
but contribution in excess of the minimum still reduce future
minimum contributions.
It has been my pleasure to discuss this proposal today. My
colleagues and I look forward to answering any questions you
may have.
[The prepared statement of Mr. Warshawsky follows:]
Statement of Mark J. Warshawsky, Assistant Secretary for Economic
Policy, U.S. Department of the Treasury, Washington, DC
Good afternoon Chairman Boehner, Ranking Member Miller, and members
of the Committee. I appreciate the opportunity to participate in this
hearing to discuss the Administration's proposal to reform and
strengthen the single employer defined benefit pension system. In my
testimony, I will focus on the proposal's funding rules, in particular,
the calculation of the funding targets.
The single employer defined benefit pension system is in serious
financial trouble. Many plans are badly underfunded, jeopardizing the
pensions of millions of American workers. The insurance system
protecting these workers in the event that their own pension plans fail
has a substantial deficit. Such a deficit means that although the PBGC
has sufficient cash to make payments in the near-term, without
corrective action, ultimately the insurance system will simply not have
adequate resources to pay all the benefits that it owes to the one
million workers and retirees currently owed benefits who were
participants of failed plans and to the beneficiaries of plans that
fail in the future.
The Administration believes that current problems in the system are
not transitory nor can they be dismissed as simply the result of
restructuring in a few industries. The cause of the financial problems
is the regulatory structure of the defined benefit system itself.
Correcting these problems and securing the retirement benefits of
workers and retirees requires that the system be restructured. Minor
tinkering with existing rules will not be sufficient. If we want to
retain defined benefit plans as a viable option for employers and
employees, fundamental changes must be made to the system to make it
financially sound.
A defined benefit pension plan is a trusteed arrangement under
which an employer makes a financial commitment to provide a reliable
stream of pension payments to employees in exchange for their service
to the firm. One cannot expect that such obligations will be honored
consistently if they are allowed to remain chronically underfunded as
they are under current law. The incentives for financially sound plan
funding must be improved or we will continue to see pension plans
terminating with massive amounts of unfunded benefits. These unfunded
benefits are costly both to participants because many lose benefits and
also to other pension sponsors because, they are likely bear the higher
costs that such underfunding imposes on the insurance system through
even higher premiums.
The goal of the Administration's proposed defined benefit pension
reform is to enhance retirement security. The reforms are designed to
ensure that plans have sufficient funds to meet accurately and
meaningfully measured accrued obligations to participants. The current
defined benefit pension funding rules--which focus on micromanaging
annual cash flows to the pension fund--are in need of a complete
overhaul. The current rules are needlessly complex and fail to ensure
that many pension plans remain prudently funded. The current rules:
<bullet> Measure plan assets and liabilities inaccurately.
<bullet> Fail to ensure adequate plan funding.
<bullet> Fail to allow sufficient contributions by plans in good
economic times, making minimum required contributions rise sharply in
bad economic times.
<bullet> Permit excessive risk of loss to workers.
<bullet> Are burdensome and unnecessarily opaque and complex.
<bullet> Do not provide participants or investors with timely,
meaningful information on funding levels.
<bullet> Do not generate sufficient premium revenues to sustain
the PBGC.
<bullet> Create a moral hazard by permitting financially troubled
companies with underfunded plans to make benefit promises they cannot
keep.
The President's solution to these issues is to fundamentally reform
the rules governing pension plan funding, disclosure and PBGC premiums,
based on the following three simple principles:
<bullet> Funding rules should ensure pension promises are kept by
improving incentives to fund plans adequately.
<bullet> Workers, investors and pension regulators should be fully
aware of pension plan funding status.
<bullet> Premiums should reflect a plan's risk and ensure the
pension insurance system's financial solvency.
Such changes will increase the likelihood that workers and retirees
actually receive the benefits that they have earned and as a result
will moderate future insurance costs that will be borne by sound plan
sponsors. Today I am going to discuss how the Administration's
initiative improves incentives for adequate plan funding. We have
proposed a fundamental reform of the treatment of defined benefit
pension plans, one that we believe will change plan sponsor behavior,
ultimately result in better funded and better managed defined benefit
pension plans, and secure benefits for workers and retirees.
The Administration proposal is designed both to simplify funding
rules and to enhance pension plan participants' retirement security.
The federal government has an interest in defining and enforcing
minimum prudent funding levels, but many other funding, investment, and
plan design decisions are best left to plan sponsors. Under this
proposal, pension plans would be required to fund towards an
economically meaningful funding target--a measure of the currently
accrued pension obligations. Plans that fall below the minimum funding
target would be required to fund-up to the target within a reasonable
period of time. Plans that fall significantly below the minimum
acceptable funding level would also be subject to benefit restrictions.
Some key features of the proposed funding rules:
<bullet> Funding based on meaningful and accurate measures of
liabilities and assets. The proposal provides funding targets that are
based on meaningful, timely, and accurate (using the yield curve for
discounting is a central component of this proposal) measures of
liabilities that reflect the financial health of the employer.
<bullet> Accrued benefits funded. Sponsors that fall below minimum
funding levels will be required to fund up within a reasonable period
of time. The proposal requires a 7-year amortization period for annual
increases in funding shortfalls. There will be restrictions on the
extension of new benefit promises by employers whose plans' funded
status falls below acceptable levels. Benefit restrictions will limit
liability growth as a plan becomes progressively underfunded relative
to its funding target.
<bullet> Plan sponsors able to fund plans during good times. Many
believe that the inability of plan sponsors to build sufficiently large
funding surpluses during good financial times under current rules has
contributed to the current underfunding in the pension system. The
proposal addresses this problem directly by creating two funding
cushions that, when added to the appropriate funding target, would
determine the upper funding limit for tax deductible contributions. And
every plan will be allowed to fund to a level of funding corresponding
to the total cost of closing out the plan. Under our proposal, allowing
plan sponsors the opportunity to prefund and therefore limit
contribution volatility is a critical element.
Some argue that the best way to enhance retirement security is to
create the appearance of well funded pension plans through the use of
asset and liability smoothing and increased amortization periods for
actuarial losses. In addition, plan sponsors have frequently voiced
their dislike of volatile and unpredictable minimum contributions.
Our view is there are significant risks associated with masking the
underlying financial and economic reality of underfunded pension plans.
Failure to recognize risk because of the use of smoothing mechanisms
results in transfers of risk among parties, in particular from plan
sponsors to plan participants and the PBGC. One need only look at the
losses incurred by many steel and airline plan participants and PBGC's
net position to see this is so.
Moreover, the Administration recognizes that the current minimum
funding rules--particularly the deficit reduction contribution
mechanism and the limits on tax deductibility of contributions--have
contributed to funding volatility. Our proposal is designed to remedy
these issues; for example, we increase the deductible contribution
limit. We feel this additional ability to fund during good times,
combined with other provisions of the proposal; for example, increasing
the amortization period to seven years compared to a period as short as
four years under the current law deficit reduction contribution
mechanism, together with the existing freedom of plans have to choose
pension fund investments, will give plans the tools they need in order
to smooth contributions over the business cycle. Plans may choose to
limit volatility by choosing an asset allocation strategy or
conservative funding level so that financial market changes will not
result in large increases in minimum contributions. These are
appropriate methods for dealing with risk; it is inappropriate to limit
contribution volatility by transferring risk to participants and the
PBGC.
Meaningful and Accurate Measures of Assets and Liabilities
We propose measuring liabilities on an accrual basis using a single
standard liability measurement concept that does not distort the
measures by smoothing values over time. Within the single method,
liability is measured using assumptions that are appropriate for a
financially healthy plan sponsor (investment grade credit rated), and
alternatively using assumptions that are appropriate for a less healthy
plan sponsor (below investment grade) that is more likely to find
itself in a position of default on pension obligations in the short to
medium term.
On-going liability is defined as the present value on the valuation
date of all benefits that the sponsor is obligated to pay. Salary
projections would not be used in determining the level of accrued
benefits. Expected benefit payments would be discounted using the
corporate bond spot yield curve that will be published by the Treasury
Department based on market bond rates. Retirement assumptions will be
developed using reasonable methodologies, based on the plan's or other
relevant recent historical experience. Finally, unlike the current
liability measure under current law, plans would be required to
recognize expected lump sum payments in computing their liabilities.
The at-risk liability measure estimates the liabilities that would
accrue as a plan heads towards termination because of deteriorating
financial health of the plan sponsor. At-risk liability would include
accrued benefits for an ongoing plan, plus increases in costs that
occur when a plan terminates. These costs include acceleration in early
retirement, increase in lump sum elections when available and the
administrative costs associated with terminating the plan.
The following table provides a summary overview of the critical
differences between the ongoing and at-risk liability assumptions.
[GRAPHIC] [TIFF OMITTED] T9772.001
Under our proposal, assets will be valued based on market values on
the valuation date for determining minimum required and maximum
allowable contributions. No smoothed actuarial values of assets will be
used as they mask the true financial status of the pension plan.
One aspect of our liability measurement approach that has received
a fair amount of attention is the use of the yield curve to discount
pension plan liabilities. Accuracy requires that the discount rates
used in calculating the present value of a plan's benefit obligations
satisfy two criteria: they must reflect the timing of the future
payments, and they should be based on current market-determined
interest rates for similar obligations. The Administration proposes to
replace the current law method with a schedule of rates drawn from a
spot yield curve of high grade (AA) corporate bonds averaged over 90
business days. Discounting future benefit cash flows using the rates
from the spot yield curve is the most accurate way to measure a plan's
liability because, by matching the maturity of the discount rate with
the timing of the obligation, it properly computes today's cost of
meeting that obligation. Use of a yield curve is a prudent and common
practice; yield curves are regularly used in valuing other financial
instruments including mortgages, certificates of deposit, etc.
The Treasury Department has developed a corporate bond yield curve
that is appropriate for this purpose. Our methodology allows spot yield
curves to be estimated directly from data on corporate AA bonds. The
process incorporates statistically unbiased adjustments for bonds with
embedded call options, and allows for statistically unbiased
projections of yields beyond a 30-year maturity. We recently published
a white paper detailing our methodology (Creating a Corporate Bond Spot
Yield Curve for Pension Discounting Department of The Treasury, Office
of Economic Policy, White Paper, February 7, 2005) that is available on
the Treasury Department web site.
Our budget proposal to reform the calculation of lump-sum benefits
also uses the yield curve for calculating the minimum lump sums. We
propose to replace the use of a 30-year Treasury rates for purposes of
determining lump sum settlements under qualified plans. Using the yield
curve to compute lumps sums and the funding required for an annuity
eliminates any distortions that would bias the participant's payout
decision. Under our proposal, lump sum settlements would be calculated
using the same interest rates that are used in discounting pension
liabilities: interest rates that are drawn from a zero-coupon corporate
bond yield curve based on the interest rates for high quality corporate
bonds. This reform includes a transition period, so that employees who
are expecting to retire in the near future are not subject to an abrupt
change in the amount of their lump sums as a result of changes in law.
The new basis would not apply to distributions in 2005 and 2006 and
would be phased in for distributions in 2007 and 2008, with full
implementation beginning only in 2009.\1\
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\1\ This is a different yield curve phase-in schedule than proposed
for the use of the yield curve in discounting pension liabilities for
minimum funding purposes.
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An Example of Discounting Liabilities Using the Yield Curve
Today, I'll provide an example (economists call this a stylized
example) of how the yield curve would be used in discounting pension
obligations. The yield curve is used to discount the plans aggregate
expected pension payments in each year to participants. The plan
administrator has calculated these future pension payments based on the
plan's formula for benefits that participants have earned up to the
valuation date. As this example shows, once the actuary has determined
the plan's annual cash benefit payments summed over all participants in
a manner similar to what is done under current law, discounting those
payments using the yield curve is quite simple.
Our hypothetical plan consists of three individuals, the 64-year-
old Mr. Brown, the 59-year-old Ms. Scarlet, and the 54-year-old Mr.
Green. Each of the three retires at age 65 and receives the same
pension benefit payment each year until death at age 80. The benefit
Mr. Brown has earned to date is higher than Ms. Scarlet's (it is
assumed that he has been working longer under the plan) whose expected
benefit is in turn larger than Mr. Green's. Mr. Brown's annual benefit
under the plan is $12,000, Ms. Scarlet's is $9,000 and Mr. Green's is
$6,000.
Chart 1 shows the AA corporate bond yield curve that would be used
to discount these benefit payments. The yield curve has interest rates
for years 0 to 80. For our stylized example we will only need to use
points for the years 1 through 26 because we assume that no participant
will draw benefits before year 1 and all payments will be made by year
26. The example applies the yield curve to payments made each year.
[GRAPHIC] [TIFF OMITTED] T9772.002
Chart 2 shows the benefit payments that each participant is
expected to receive in the future. Chart 3 shows expected total
payments that will be made by the plan each year in the future; this is
simply the sum of payments to the three individual participants. The
total benefit line takes an upward step each time a participant retires
and a downward step each time a participant's benefit ends.
[GRAPHIC] [TIFF OMITTED] T9772.003
[GRAPHIC] [TIFF OMITTED] T9772.004
How do we apply the yield curve to discounting these benefit
payments?
Let's take years 5, 14 and 20. In year 5, the plan expects to pay
$12,000 in benefits, all to Mr. Brown. The discount rate for that year
drawn from the yield curve is 4.03 percent. To compute the present
value of the $12,000, the $12,000 is divided by 1.218 (one plus the
interest rate expressed in decimal form, 1.0403, raised to the 5th
power), which equals $9,849.
For plan year 14 the expected benefit payments are $27,000 ($12,000
to Mr. Brown, $9,000 to Ms. Scarlet and $6,000 to Mr. Green) and the
yield curve interest rate is 5.51 percent. To compute the present
value, the $27,000 is divided by 2.119 (1.0546 taken to the 14th power)
yielding $12,742. For year 20, the plan expects to pay $15,000 ($9,000
to Ms. Scarlet and $6,000 to Mr. Green) and the discount rate from the
yield curve is 5.96 percent. Dividing $15,000 by 3.183 gives a present
value of $4,713. Note that even though there are three participants in
the plan, once their benefit payments during any period are added
together only one interest rate is needed to compute the present value
for that period. Separate interest rates are not used for every
individual participant in the plan.
In order to compute the plan's target liability the plan needs to
perform computations like the one above for each payment period from 1
through 27 and sum them together. The liability for this hypothetical
plan is $238,994. In this example, only 26 interest rates are used, one
for each year that benefit payments are made. Even if our hypothetical
plan had thousands of participants, but payments were made for only 26
years in the future, only 26 interest rates would be needed to compute
the plan's liability.
This is, of course, a simplified example. The plan actuary needs to
make a number of computations and use his or her professional judgment
to determine the plan's future benefit payments each year: the actuary
must estimate the probability that a participant will retire at a
particular time in the future and must model the probable pattern of
payments that will be made for that participant until the participant's
death. These computations, already required by current law, are
complex, but once the actuary has determined the annual cash benefit
payments, discounting those payments using the yield curve is quite
simple and can easily be done using a basic spreadsheet program.
As noted above, if Mr. Brown elected to take a lump sum payment
rather than an annuity, the minimum value of that lump sum would also
be computed using the yield curve. We have assumed that Mr. Brown will
begin receiving his annual benefit of $12,000 next year and will
receive the same benefit for 16 years. In order to compute the value of
those future payments as a lump sum we would simply discount each
period's cash flows using interest rates drawn from the yield curve to
find the present value of the benefit in each future period. Then we
sum those present values together to yield the minimum lump sum value.
In year one, for example, the interest rate drawn from the yield curve
is 2.59 percent. If the first $12,000 payment is made one year in the
future its present value would be $11,697. The present value of the
payment made in year 5 would be computed using the year 5 point on the
yield curve that is 4.03 percent. Its present value would be $9,849. In
year 12, the interest rate used to compute the present value is 5.29
percent and therefore the present value of the benefit payment is
$6,465. In total, Mr. Brown's hypothetical lump sum would be valued at
$131,035.
Distinction by Credit Rating
Under the Administration's proposal, the appropriately measured
accrued liabilities serve as the plan funding targets. The target
funding level for minimum required contributions will vary depending on
the financial health of the plan sponsor. Plans sponsored by
financially healthy firms (investment grade rated) will use 100 percent
of ongoing liability as their funding target. Less healthy plan
sponsors (below investment grade rated) will use 100 percent of at-risk
liability as their funding target.\2\
---------------------------------------------------------------------------
\2\ The proposal includes a detailed description of the transition
rules that govern the phase in of the higher funding target when a plan
changes status from ongoing to at-risk. See the Treasury Blue Book for
more information at http://www.treas.gov/offices/tax-policy/library/
bluebk05.pdf.
---------------------------------------------------------------------------
The goal of pension funding rules is to minimize benefit losses to
plan participants. When pension plans default on their obligations, the
PBGC is required to make benefit payments to plan participants subject
to the guarantee limits. Ultimately, if plan defaults are too numerous,
the insurance system will collapse and taxpayers may be called upon to
fund the pension promises. Pension plans sponsored by firms with poor
credit ratings pose the greatest risk of such defaults. Therefore, it
is only natural that pension plans with sponsors that fall into this
readily observable high risk category should have more stringent
funding standards. The at-risk liability measure is an appropriate
funding target for below investment grade companies because the target
reflects the plan liabilities that would accrue as a plan heads towards
termination.
The table below shows the average cumulative default rate of
corporate bond issuers as computed by Moody's Investor's Service
(January 2005). This table indicates that, over time, below investment
grade firms have a substantially higher likelihood of default than
investment grade firms. The table indicates that 14.81 percent of Ba
rated firms (just below investment grade) experience a default within 7
years, whereas only 3.12 percent of Baa rated firms (just above
investment grade) experience a default within the same period.
[GRAPHIC] [TIFF OMITTED] T9772.005
The following chart shows that firms generally have a below
investment grade credit rating for several years prior to their plan
default on pension obligations triggering a claim on the PBGC. This
shows 27 largest claims to PBGC for which the series of S&P ratings
were available. This suggests that while defaults are certainly not
easily predictable (many other plans with below investment grade credit
ratings did not default), these are clear warning signs that any
responsible regulatory system should take into account. Differentiating
funding targets based on credit ratings is appropriate and the
investment grade/below investment grade distinction is the most useable
and accurate breakpoint.
[GRAPHIC] [TIFF OMITTED] T9772.006
Accrued Benefits Funded
Under the proposal, sponsors that fall below minimum funding levels
would be required to fund up towards their appropriate target in a
timely manner. If the market value of plan assets is less than the
funding target for the year, the minimum required contribution for the
year would be equal to the sum of the applicable normal cost for the
year and the amortization payments for the shortfall. Amortization
payments would be required in amounts that amortize the funding
shortfall over a 7-year period. The initial amortization base is
established as of the valuation date for the first plan year and is
equal to the excess, if any, of the funding target over the market
value of assets as of the valuation date. The shortfall is amortized in
7 annual level payments. For each subsequent plan year, if the sum of
the market value of assets and the present value of future amortization
payments is less than the funding target, that shortfall is amortized
over the following 7 years. If the sum of the market value of assets
and the present value of future amortization payments exceeds the
funding target, no new amortization base would be established for that
year and the total amortization payments for the next year would be the
same as in the prior year. When, on a valuation date, the market value
of the plan's assets equals or exceeds the funding target, then the
amortization charges would cease and all existing amortization bases
would be eliminated.\3\
---------------------------------------------------------------------------
\3\ This description draws on the description in the Treasury Blue
Book.
---------------------------------------------------------------------------
It is critical to note that while our proposal does away with
``credit balances'' as currently construed, it does not reduce the
incentives to contribute above the minimum. It does, however, prevent
underfunded plans from using credit balances for funding holidays.
Because credit balances currently are not marked to market and can be
used by underfunded plan sponsors, they have resulted in plans having
lengthy funding holidays, while at the same time becoming increasingly
underfunded. Just marking credit balances to market is not sufficient
to solve the problem if underfunded plan are still able to take funding
holidays. In the Administration proposal, the focus of the reformed
funding rules on stocks of assets and accrued liabilities means that
pre-funding pays off in a reduction in future required minimum
payments. Under a reformed set of funding rules, pre-funding adds to a
plan's stock of assets, thereby reducing any current shortfalls or the
likelihood of potential future shortfalls relative to appropriately and
accurately measured liabilities.
An Example of Funding Rules
Using another example we can demonstrate how minimum contributions
would be determined under the funding proposal. Liabilities for the
plan are computed over a five-year period using the cash flows and the
yield curve depicted in the graphs above. (For simplicity, it is
assumed that the yield curve interest rates remain constant over the
five-year period.) We then begin with an arbitrarily chosen level of
plan underfunding to demonstrate how the amortizations of plan deficits
would work. For this example, we simplify and assume that the interest
rate charged for amortization of shortfalls is zero. That means that a
shortfall increase payment amortized over 7 years is merely the
increase divided by 7. The normal cost is also assumed to be zero to
simplify the exposition.
In year one, the plan is underfunded by $18,994. That means that
the plan must contribute a minimum of $2,713, which is the amortization
payment for $18,994 over a seven year term--in year one and for the
next six years--unless the plan becomes fully funded before year seven.
In year two, the plan's funding deficit is $8,000 as a result of
increases in both the value of assets and liabilities. Since this new
shortfall is less than the value of future contributions (we assume
that the plan will make future contributions so their present value
effectively becomes an asset) the increase in the shortfall is zero.
Under the amortization rules no new payment is required; because the
plan is still underfunded, however, a second payment of $2,713 must be
made. The amortization rule is designed to encourage plans to fund up
quickly in order to protect participants' pensions. For that reason,
the amortization payment of $2,713 is not reduced even though the
plan's funded status has improved.
In year 3, the funding shortfall increases to $18,367 because the
value of assets has fallen. Because this is $4,800 more than the value
of the remaining amortization payments, a new payment of $686 is added
to the existing payment of $2,713 meaning that total contributions are
$3,399 in year 3.
In year 4, because of an increase in asset values, the plans
deficit falls to $9,283. This is less than $14,968, the value of the
remaining shortfall payments from year 1 and year 3 so there is no new
payment and the required contribution remains $3,399.
In year 5, asset values rise again and the plan is now fully
funded. Because the plan no longer has a funding deficit, no minimum
contribution is required and all past amortization payments are
cancelled.
[GRAPHIC] [TIFF OMITTED] T9772.007
Benefit Restrictions
Finally, we have proposed benefit restrictions that will limit
liability growth as a plan becomes progressively underfunded relative
to its funding target. It is important to arrest the growth of
liabilities when plans are becoming dangerously underfunded in order to
ensure that plan participant will collect benefits that they accrue.
Under current law, sponsors of underfunded plans can continue to
provide for additional accruals and, in many situations even make
benefit improvements. Plan sponsors in financial trouble have an
incentive to promise generous pension benefits, rather than increase
current wages, and employees may go along because of the PBGC
guarantee. This increases the likely losses faced by participants and
large claims to the PBGC. To guard against this type of moral hazard,
if a company's plan is poorly funded, the growth in the plan's
liabilities should be limited unless and until the company funds them,
especially if the company is in a weak financial position.
Plan sponsors able to fund plans during good times
The Administration proposed reforms provide real and meaningful
incentives for plans to adequately fund their accrued pension
obligations. The importance of these mechanisms that I have described
is not simply to force plans to fund-up quickly and reduce the rate at
which new obligations accrue. Their importance is also that rational,
forward looking managers will respond to these reforms by taking steps
to ensure that plans remain well funded on an ongoing basis. The
Administration plan matches new responsibilities, to more fully fund
pension obligations, with new opportunities--an enhanced ability to
pre-fund obligations on a tax preferred basis.
Pension sponsors believe that their inability, under current rules,
to build sufficiently large funding surpluses during good financial
times has contributed significantly to current underfunding in the
pension system. The proposal addresses this problem directly by
creating two funding cushions that, when added to the appropriate
funding target, would determine the upper funding limit for tax
deductible contributions. Every plan will be allowed to fund to at
least at-risk Liability.
The first cushion is designed to allow firms to build a sufficient
surplus so that plans do not become underfunded solely as a result of
asset and liability values fluctuations that occur over a business
cycle. Plan sponsors would also be able to build a second funding
cushion that allows them to pre-fund for salary or benefit increases.
Conclusion
Defined benefit plans are a vital source of retirement income for
millions of Americans. The Administration is committed to ensuring that
these plans remain a viable retirement option for those firms that wish
to offer them to their employees. The long run viability of the system,
however, depends on ensuring that it is financially sound. The
Administration's proposal is designed to put the system on secure
financial footing in order to safeguard the benefits that plan
participants have earned and will earn in the future. We are committed
to working with Congress to ensure that effective defined benefit
pension reforms that protect worker's pensions are enacted into law.
It has been my pleasure to provide this detailed discussion of some
of the critical elements of the proposal. My colleagues and I are
available and look forward to discussing the proposal and the
motivations for the proposal and answering any additional questions you
may have.
______
Chairman Boehner. Thank you.
Ms. Combs.
STATEMENT OF ANN COMBS, ASSISTANT SECRETARY OF LABOR, EMPLOYEE
BENEFITS SECURITY ADMINISTRATION, WASHINGTON, DC
Ms. Combs. Good morning, Chairman Boehner, Mr. Miller, and
Members of the Committee. Thank you for inviting us today to
discuss the administration's proposal.
As you've noted, the defined benefit system needs
comprehensive reform. Mere tinkering with the current rules
will not fix its problems.
The administration's reform package will improve pension
security for workers and retirees, stabilize the defined
benefit system, and avoid the need for a taxpayer bailout of
the PBGC.
I will focus today on three elements of the proposal:
preventing hollow benefit promises by severely under-funded
pension plans; improving disclosure to workers, investors, and
regulators; and reforming PBGC premiums to better reflect the
real risks and costs of the pension guarantee program.
Under the current funding rules, financially weak companies
can promise new benefits and make lump-sum payments that the
plan cannot afford. Workers, retirees, and their families who
rely on these empty promises can face serious financial
hardship if the pension plan is terminated.
The administration's proposal would prevent this by
ensuring that companies make promises they can afford and keep
the promises they make.
First, the proposal would allow a plan to increase benefits
only if the plan is more than 80 percent funded or if the new
benefits are fully and immediately paid for.
Second, a plan could not make lump-sum payments unless it
is more than 60 percent funded, or if the plan sponsor is
financially week, more than 80 percent funded. This will ensure
that workers are treated fairly, preventing a run on the bank
where a few collect at the expense of those left behind in the
plan.
Third, plans sponsored by financially weak companies that
are less than 60 percent funded would have no new benefit
accruals until their funded status improves, and plans
sponsored by bankrupt companies would be frozen until the plans
were fully funded.
Our proposal also prevents corporate executives from
securing their own retirements while workers' plans are at
risk, an abuse recently seen in the airline industry.
Financially weak companies with severely under-funded plans
could not secure non-qualified deferred executive compensation
arrangements, and funds used for this purpose could be
recovered by the under-funded pension plan.
Plans that become subject to any of these benefit
limitations would be required to notify affected workers,
making them aware that deteriorating funding is threatening
their benefits.
These restrictions create a strong incentive for employers
to adequately fund their plans, and they ensure that the
promises already made to workers are honored before additional
empty promises are made, raising false expectations that cannot
be met.
The financial health of defined benefit plans must be
transparent and fully disclosed to workers and retirees as well
as to regulators and investors.
The administration's proposal would accelerate and improve
annual disclosures to covered workers and retirees. Each plan
would disclose its funded status relative to its funding target
for the current year and for the two preceding years, along
with information about the companies' financial health and PBGC
guarantees.
These disclosures will ensure that workers have the
information they need to talk to their employers about the
funding of their plans and to make informed choices about their
own retirements.
It will correct the current situation, where so many
workers and retirees have lost benefits with little or no
advance warning, having been told that their plans were
adequately funded.
Another key reform is to improve the timeliness and
accuracy of annual plan reports to the government.
Under current law, the information reported doesn't
accurately measure assets and liabilities, and can be nearly 2
years out of date.
We would require plans to report annually the market value
of their assets and the ongoing and at-risk liability--value of
their liabilities, as well as shorten the deadline for large
under-funded plans to report their actuarial information.
In addition, our proposal allows information filed by
certain under-funded plans with the PBGC to be disclosed to the
public, except for sensitive information such as trade secrets
that is protected under the Freedom of Information Act.
Finally, our proposal will restore the financial integrity
of the Federal insurance system by improving the PBGC premium
structure.
It would immediately adjust the flat, per-participant
annual premium to $30 to reflect the growth in worker wages
since 1991 when the current $19 figure was set. The rate would
be indexed to wage growth, similar to the way the PBGC
guarantee limit is indexed.
All companies with under-funded plans would pay an
additional risk-based premium based on the plan's funding
shortfall. The rate would be set periodically by the PBGC board
to ensure sufficient premium revenue to meet expected claims
and pay off the current deficit over time.
This new risk-based premium would be based on more accurate
funding targets and reflect the sponsor's financial condition,
which would be an improvement over the current law.
To keep premiums to a reasonable level by reducing
unreasonable risk, we would freeze the PBGC guarantee limit
when a company enters bankruptcy, allow the PBGC to perfect
liens for most required contributions, and prospectively
eliminate the guarantee of shutdown benefits and prohibit such
under-funded benefits in pension plans.
In conclusion, we are committed to working with Congress to
ensure that there's meaningful defined benefit pension reforms
enacted into law. We look forward to working with the Members
of this Committee to achieve greater retirement security for
the millions of American workers, retirees, and their families
who depend on defined benefit plans.
Thank you very much, and we would all be happy to take
questions.
[The prepared statement of Ms. Combs follows:]
Statement of Ann L. Combs, Assistant Secretary of Labor, Employee
Benefits Security Administration, U.S. Department of Labor, Washington,
DC
Introductory Remarks
Good morning Chairman Boehner, Ranking Member Miller, and members
of the Committee. Thank you for inviting me to discuss the
Administration's proposal to reform and strengthen the single-employer
defined benefit pension system.
The Bush Administration believes that the pension promises
companies have made to their workers and retirees must be kept. Single-
employer, private sector defined benefit pension plans cover 16 percent
of the nation's private workforce, or about 34 million Americans. The
consequences of not honoring pension commitments are unacceptable--the
retirement security of millions of current and future retirees is put
at risk.
However, the current system does not ensure that pension plans are
adequately funded. As a result, pension promises are too often broken.
Termination of plans without sufficient assets to pay promised
benefits has a very real human cost. Many workers' and retirees'
expectations are shattered, and, after a lifetime of work, they must
change their retirement plans to reflect harsh, new realities.
Underfunded plan terminations are also placing an increasing strain on
the pension guaranty system.
Increased claims from terminations of significantly underfunded
pension plans have resulted in a record deficit in the single-employer
fund of the PBGC. For the fiscal year ending September 30, 2004, the
PBGC reported a record deficit of $23.3 billion in that fund. The
increasing PBGC deficit and high levels of plan underfunding are
themselves a cause for concern. More importantly, they are symptomatic
of serious structural problems in the private defined benefit system.
It is important to strengthen the financial health of the defined
benefit plan system now. If significantly underfunded pension plans
continue to terminate, not only will some workers lose benefits, but
other plan sponsors, including those that are healthy and have funded
their plans in a responsible manner, will be called on to pay far
higher PBGC premiums. Underfunding in the pension system must be
corrected now to protect worker benefits and to ensure taxpayers are
not put at risk of being called on to pay for broken promises.
The Administration has developed a reform package to improve
pension security for workers and retirees, stabilize the defined
benefit system, and avoid a taxpayer bailout of PBGC. The President's
proposal is based on three main elements:
First, the funding rules must be reformed to ensure that plan
sponsors adequately fund their plans and keep their pension promises.
The current system is ineffective and needlessly complex. The rules
fail to ensure that many pension plans are and remain adequately
funded.
Second, disclosure to workers, investors and regulators about
pension plan status must be improved. Workers need to have good
information about the funding status of their pension plans to make
informed decisions about their retirement needs and financial futures.
Too often in recent years, participants have mistakenly believed that
their pension plans were well funded, only to receive a rude shock when
the plan is terminated. Regulators and investors also require more
timely and accurate information about the financial status of pension
plans than is provided under current law.
Third, premium rates must be revised to more accurately reflect the
risk of a plan defaulting on its promises and to help restore the PBGC
to financial health. The current premium structure encourages
irresponsible behavior by not reflecting a plan's true level of risk.
The proposal would strengthen the funding rules and defined benefit
system, so that the nation's workers and retirees can be confident of
the secure retirement they have worked for all their lives. I will now
discuss the key provisions for each element of the President's proposal
and the reasons these provisions are needed to protect the pensions of
the 34 million Americans who are relying on the single-employer defined
benefit pension promises made by their employers.
Reforming the Funding Rules
The funding rules are complicated and ineffective.
Current funding rules do not establish accurate funding targets and
the lack of adequate consequences for underfunding a plan provides
insufficient incentive for plans to become well funded. In addition,
the funding rules fail to take into account the risk that a plan
sponsor will fail.
Weaknesses in the current rules include, for example, multiple and
inaccurate asset and liability measures and discount rates, smoothing
mechanisms, credit balances that allow funding holidays to continue
even as funding levels deteriorate, excessive discretion over actuarial
assumptions, and varying and excessively lengthy amortization periods.
As a result, companies can say their plans are fully funded when in
fact they are substantially underfunded. Together these weaknesses
allow companies to avoid making contributions when their plans are
substantially underfunded. And in some circumstances, they actually
prevent companies that want to increase funding of their pension plans
from making additional contributions during good economic times.
These weaknesses contribute to the ability to manipulate funding
targets which is of particular concern given the fact that they are set
too low. There is no uniformity in liability measures under current
law. In some cases, employers can stop making contributions when a plan
is funded at 90 percent of ``current liability.'' But current liability
is not an accurate measure of pension funding requirements; even 100
percent of current liability is often far less than what will be owed
if a plan is terminated. As a result, employers can stop making
contributions before a plan is sufficiently funded to protect
participants in the event of termination.
Why is current liability such a poor measure of true pension costs?
One reason is that the interest rate used in determining current
liability can be selected from an interest rate corridor that is based
on an average of interest rates over the prior 48 months. As a result,
during periods of rapidly changing interest rates, the current
liability interest rate may bear little relationship to economic
reality and misstate the risks to plan participants. Even if the
current liability interest rate reflected current market conditions, it
would produce an inaccurate measure of the plan's true liability
because it is based on a long-term interest rate and fails to take into
account the actual timing of when benefit payments will be due under
the plan. That timing often is considerably sooner, especially for
plans with a large number of older participants near retirement age.
Current liability also fails to account for the risk of plan
termination. This is important because terminating plans incur
additional costs not reflected in current liability. For example, when
plans terminate, participants are more likely to draw benefits early
and elect lump sums. Terminating plans must purchase insurance
annuities at prices that reflect market interest rates and
administrative expenses. These factors combine to escalate costs above
those reflected in current liability, often by large amounts. While it
is not necessary for all plans to fund to such a standard, in the case
of a plan with a substantial risk of terminating, the pension funding
target should take into account the additional costs of terminating the
plan.
Another weakness in the funding rules is their reliance on the so-
called ``actuarial value'' of plan assets. The actuarial value of plan
assets may differ from the fair market value of plan assets. It may be
determined under a formula that ``smooths'' fluctuations in market
value by averaging the value over a number of years. The use of a
smoothed actuarial value of assets distorts the funded status of the
plan. Using fair market value for purposes of the funding rules would
give a clearer and more accurate picture of a plan's ability to pay
promised benefits.
As an example of how all of this can affect workers and retirees,
the U.S. Airways pilots' plan was 94 percent funded on a current
liability basis, but the plan was only 33 percent funded on a
termination basis, with a $1.5 billion shortfall. After believing their
pensions were substantially secure, U.S. Airways pilots were shocked to
learn how much of their promised benefits would be lost. Bethlehem
Steel's plan was 84 percent funded on a current liability basis, but
the plan turned out to be only 45 percent funded on a termination
basis, with a total shortfall of $4.3 billion.
The Bush Administration's Proposal
The current funding rules must be strengthened to ensure that
accrued benefits are adequately funded. This is particularly important
for those plans at the greatest risk of terminating. The
Administration's plan will bring simplicity, accuracy, stability, and
flexibility to the funding rules, encouraging employers to fully fund
their plans and ensuring that benefit promises are kept.
Under the President's proposal, the multiple sets of funding rules
applicable to single-employer defined benefit plans would be replaced
with a single set of rules. The rules would provide for each plan a
single funding target that is based on meaningful, accurate measures of
its liabilities that reflect the financial health of the employer and
use fair market values of assets. Funding shortfalls would be amortized
and paid over 7 years. Plan sponsors would have the opportunity to make
additional, tax-deductible contributions in good years, even when the
plan's assets are substantially above its funding target. In addition
to the changes to the funding rules, new limits would be placed on
unfunded benefit promises, reporting and disclosure of funding
information would be improved, and PBGC premiums would be reformed to
more fully reflect the risks and costs to the insurance program.
Funding targets will depend on the plan sponsor's financial
health.
Pension liability computations should reflect the true present
value of accrued future benefits--this is a key component of accuracy.
Workers and retirees are interested in the present value of liabilities
so that they can determine whether their plans and promised benefits
are adequately funded. Plan sponsors and investors are interested in
the present value of liabilities in order to determine the demands
pension liabilities will place on the company's cash flows.
The Administration's proposal provides a single conceptual measure
of liabilities based on benefits earned to date. Assumptions are
modified as needed to reflect the financial health of the plan sponsor
and the risk of termination posed by the plan. A plan's funding target
would be the plan's ongoing, or alternatively, its at-risk liability,
depending on the sponsor's financial health.
For a plan sponsor that is healthy, the funding target would be the
plan's ongoing liability. The plan sponsor is considered financially
healthy if any member of the plan sponsor's control group has senior
unsecured debt rated as being investment grade (Baa or better). If a
plan sponsor is financially weak, the funding target generally would be
the plan's at-risk liability. A plan sponsor is considered financially
weak if its senior unsecured debt is rated as below investment grade by
every rating agency that rates the sponsor. A plan's funding target
would phase up from ongoing to at-risk over a five-year period.
Conversely, if a plan's credit rating is upgraded to investment grade,
its funding target would immediately drop to ongoing liability.
Credit ratings are used to measure financial health because
empirical evidence shows that a company's time spent in below
investment grade status is a strong indicator of the likelihood of plan
termination. It is also critical that a market-based test be used to
establish financial health.
A plan's ongoing liability is equal to the present value of all
benefits that the plan is expected to pay in the future, based on
benefits earned through the beginning of the plan year. Workers are
assumed to retire and to choose lump sums as others have in the past. A
plan's at-risk liability is based on the same benefits, but assumes
that employees will take lump sums and retire as soon as they can, and
includes an additional amount reflective of the transaction cost of
winding up a plan. These assumptions are designed to reflect behavior
that typically occurs prior to plan termination when the financial
health of the employer deteriorates.
The applicable funding target is calculated by discounting benefit
liabilities based on a yield curve of long-term corporate bonds. The
discount rate would reflect the duration of the liabilities. A plan's
actuary would project the plan's cash flow in each future year and
discount payments using the appropriate interest rate for the payment.
In general, with a typical yield curve, plans with older workforces
where payments are due sooner will discount a greater proportion of
their liabilities with the lower interest rates from the short-end of
the yield curve than plans with younger workforces where larger cash
payments are delayed into the future. The corporate bond yield curve
would be published by the Secretary of Treasury and would be based on
the interest rates, averaged over 90 business days, for high quality
corporate bonds rated AA, with varying maturities.
The use of a single conceptual measure of liabilities will simplify
the funding rules. It will tell plan sponsors, investors, regulators,
and most importantly, workers and retirees, whether a plan is
adequately funded.
Funding shortfalls should be made up over a reasonable
period.
Another problem with the current funding rules is that underfunded
plans are permitted to make up their shortfalls over too long a period
of time. In addition, underfunded plans are permitted funding holidays.
These rules put workers at risk of having their plans terminate without
adequate funding.
Under current law, if the unfunded accrued liability is
attributable to a plan amendment, the amortization period for making up
the shortfall is 30 years. Experience shows this is too long. There is
too much risk that the plan will be terminated before 30 years has
passed. Furthermore, collectively bargained plans often have a series
of benefit increases every few years, which has the effect of
increasing all of the liabilities accrued prior to the benefit increase
as well as increasing future liabilities. As a result, these plans are
perennially underfunded.
The credit balance rules for plan funding under current law also
contribute to plan underfunding. The credit balance rules allow an
employer to apply its contributions in excess of minimum requirements
from an earlier year as an offset to the minimum funding requirement
for a subsequent year without restrictions. This loophole allows a plan
to have a contribution holiday without regard to whether the additional
contributions have earned the assumed rate of interest or have instead
lost money in a down market--and, more importantly, regardless of the
current funded status of the plan. Credit balance rules harm the
retirement security of workers and retirees. In the Bethlehem Steel and
the U.S. Airways pilots' plan termination cases, for example, no
contributions were made (or required to be made, as a result of credit
balances) to either plan during the three or four years leading up to
plan termination.
Under the Administration's proposal, plans would annually
contribute enough to address their funding shortfall over a reasonable
period of time, without funding holidays, until the shortfall is
eliminated. Plan funding shortfalls would be amortized over a 7-year
period. The current law provision allowing an extension of amortization
periods would no longer be available.
Opportunity to increase funding in good years.
We also must address the overly prescriptive funding rules for
well-funded plans that discourage companies from building up a cushion
to minimize contributions in lean years. To keep healthy companies in
the defined benefit system, we need to give them better incentives.
The current funding rules can place a pension plan sponsor in the
position of being unable to make deductible contributions in one year
and then being subject to accelerated deficit reduction contributions
in a subsequent year. This problem is caused by the interaction of the
minimum funding requirements and the rules governing maximum deductible
contributions. The rules restrict employers' ability to build up a
cushion that could minimize the risk that contributions will have to be
severely increased in poor economic times. This volatility in required
contributions makes it difficult for plan sponsors to predict their
funding obligations, and makes it difficult to prevent large required
contributions during economic downturns when the company is least able
to pay.
The Administration's proposal would permit plan sponsors to make
additional deductible contributions up to a new higher maximum
deductible amount. This would permit companies to increase funding
during good economic times. Funding would be permitted on a tax-
deductible basis to the extent the plan's assets on the valuation date
are less than the sum of the plan's funding target for the plan year,
the applicable normal cost and a specified cushion. The cushion amount
would enable plan sponsors to protect against funding volatility, and
would be equal to 30 percent of the plan's funding target plus an
amount to pre-fund projected salary increases (or projected benefit
increases in a flat dollar plan). Plans would always be permitted to
fund up to their at-risk liability target.
This cushion will help provide workers and retirees greater
retirement security by increasing the assets available to finance
retirement benefits.
Limitations on plans funded below target levels.
The current rules encourage some plans to be chronically
underfunded, in part, because they shift potential losses to third
parties. This is what economists refer to as a ``moral hazard.'' Under
current law, sponsors of underfunded plans can continue to provide for
additional accruals and, in some situations, even make new benefit
promises, while pushing the cost of paying for those benefits off into
the future. For this reason, some companies have an incentive to
provide generous pension benefits that they cannot currently finance,
rather than increase wages. The company, its workers 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. Under our proposed funding
rules, financially strong companies, in contrast, have little incentive
to make unrealistic benefit promises because they know that they fund
them in a reasonably timely manner.
If a company's plan is poorly funded, the company should be
precluded from adopting further benefit increases unless it fully funds
them, especially if it is in a weak financial position. If a plan is
severely underfunded, retiring employees should not be able to elect
lump sums and similar accelerated benefits. The payment of those
benefits allows those participants to receive the full value of their
benefits while depleting the plan assets for the remaining
participants. A similar concern applies when a severely underfunded
plan purchases annuities.
The Administration believes that we must ensure that companies,
especially those in difficult financial straits, make only benefit
promises they can afford, and take steps to fulfill their promises
already made by appropriately funding their pension plans. In order to
accomplish this goal, the proposal would place additional meaningful
limitations on plans that are funded substantially below target levels.
First, the rules would limit benefit increases for certain
underfunded plans. For a plan where the market value of the plan's
assets is less than or equal to 80 percent of the funding target, no
amendment increasing benefits would be permitted. If the market value
of the plan's assets is above 80 percent of the funding target, but was
less than 100 percent for the prior plan year, then no benefit increase
amendment that would cause the market value of the plan's assets to be
less than 80 percent of the funding target would be permitted. In
either case, the sponsor could avoid the application of these limits by
choosing to contribute the minimum required contribution and the
increase in the funding target attributable to an amendment increasing
benefits.
Second, the rules would limit lump sum distributions or other
accelerated benefit distributions for certain underfunded plans. Limits
would apply if either the market value of a plan's assets is less than
or equal to 60 percent of the funding target or the plan sponsor is
financially weak and the market value of the plan's assets is less than
or equal to 80 percent of the funding target.
Third, the rules would limit accruals for plans with severe funding
shortfalls or sponsors in bankruptcy with assets less than the funding
target. A plan is considered severely underfunded if the plan sponsor
is financially weak and the market value of the plan's assets is less
than or equal to 60 percent of the funding target. These plans pose
great risk of plan termination and would effectively be required to be
frozen.
Lastly, the rules would address an abuse recently seen in the
airline industry--where executives of companies in financial difficulty
have their nonqualified deferred compensation arrangements funded and
made more secure, without addressing the risk to the retirement income
of rank and file employees caused by severely underfunded pension
plans. The rules would prohibit funding such executive compensation
arrangements if a financially weak plan sponsor has a severely
underfunded plan. Also, the rules would prohibit funding executive
compensation arrangements less than 6 months before or 6 months after
the termination of a plan where the plan assets are not sufficient to
provide all benefits due under the plan. A plan would have a right of
action under ERISA against any top executive whose nonqualified
deferred compensation arrangement was funded during the period of the
prohibition to recover the amount that was funded.
Plans that become subject to any of these benefit limitations would
be required under ERISA to furnish a related notice to affected workers
and retirees. In addition to letting workers know that limits have
kicked in, this notice will alert workers when funding levels
deteriorate and benefits already earned are in jeopardy.
Improving Disclosure to Workers, Investors, and Regulators
The financial health of defined benefit plans must be transparent
and fully disclosed to the workers and their families who rely on
promised benefits for a secure and dignified retirement. Investors and
other stakeholders also need this information because the funded status
of a pension plan affects a company's earnings and creditworthiness.
While ERISA includes a number of reporting and disclosure
requirements that provide workers with information about their employee
benefits, the timeliness and usefulness of that information must be
improved.
For example, the principal Federal source of information about
private sector defined benefit plans is the Form 5500. Schedule B, the
actuarial statement filed with the Form 5500, reports information on
the plan's assets, liabilities and compliance with funding
requirements. Because ERISA provides for a significant lapse of time
between the end of a plan year and the time when the Form 5500 must be
filed, regulatory agencies are not notified of the plan's funded status
for almost two years after the actual valuation date. If the market
value of a plan's assets is less than its funding target, the relevant
regulatory agencies need to monitor whether the plan is complying with
the funding requirements on a more current basis.
The PBGC does receive more timely information regarding a limited
number of underfunded plans that pose the greatest threat to the system
under Section 4010 of ERISA. Section 4010 data provides identification,
financial, and actuarial information about the plan. The financial
information must include 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.
However, current law prohibits disclosure, so this information may
not be made publicly available. This makes no sense. Basic data
regarding the funded status of a pension plan is vitally important to
participants and investors. Making information regarding the financial
condition of the pension plan publicly available would benefit
investors and other stakeholders and is consistent with federal
securities laws that Congress has strengthened to require the
disclosure of information material to the financial condition of a
publicly-traded company.
The most fundamental disclosure requirement of a pension's funding
status to workers under current law is the summary annual report (SAR).
The SAR discloses certain basic financial information from the Form
5500 including the pension plan's net asset value, expenses, income,
contributions, and gains or losses. Pension plans are required to
furnish a SAR to all covered workers and retirees within two months
following the filing deadline of the Form 5500.
Information on a plan's funding target and a comparison of that
liability to the market value of assets would provide more accurate
disclosure of a plan's funded status. Providing information on a more
timely basis would further improve the usefulness of this information
for workers and retirees.
The Bush Administration's Proposal
The Administration's proposal would allow information filed with
the PBGC to be disclosable to the public and would provide for more
timely and accurate disclosure of information to workers and retirees.
Provide broader dissemination of plan information.
Under the Administration's proposal, the Section 4010 information
filed with the PBGC would be made public, except for the information
subject to Freedom of Information Act protections for corporate
financial information, which includes confidential ``trade secrets and
commercial or financial information.''
Broadening the dissemination of information on pension plans with
unfunded liabilities, currently restricted to the PBGC, is critical to
workers, financial markets and the public at large. Disclosing this
information will both improve market efficiency and help encourage
employers to appropriately fund their plans.
Provide more meaningful and timely information.
The President's proposal would change the information required to
be disclosed on the Form 5500 and SAR. Plans would be required to
disclose the plan's ongoing liability and at-risk liability in the Form
5500, whether or not the plan sponsor is financially weak. The Schedule
B actuarial statement would show the market value of the plan's assets,
its ongoing liability and its at-risk liability.
The information provided to workers and retirees in the SAR would
be more meaningful and timely. It would include a presentation of the
funding status of the plan for each of the last three years. The
funding status would be shown as a percentage based on the ratio of the
plan's assets to its funding target. In addition, the SAR would include
information on the company's financial health and on the PBGC
guarantee. The due date for furnishing the SAR for all plans would be
accelerated to 15 days after the filing date for the Form 5500.
The proposal also would provide for more timely disclosure of
Schedule B information for plans that cover more than 100 participants
and that are subject to the requirement to make quarterly contributions
for a plan year (i.e., a plan that had assets less than the funding
target as of the prior valuation date). The deadline for the Schedule B
report of the actuarial statement would be shortened for those plans to
the 15th day of the second month following the close of the plan year,
or February 15 for a calendar year plan. If any contribution is
subsequently made for the plan year, the additional contribution would
be reflected in an amended Schedule B that would be filed with the Form
5500.
Reforming Premiums to Better Reflect Plan Risk and Restoring the PBGC
to Financial Health
There are two fundamental problems with PBGC premiums. First, the
premium structure does not meet basic insurance principles, including
those that govern private-sector insurance plans. Second, the premiums
do not raise sufficient revenue to meet expected claims. The single-
employer program lacks risk-based underwriting standards. Plan sponsors
face limited accountability regardless of the risk they impose on the
system. As a result, there has been a tremendous amount of cost-
shifting from financially troubled companies with underfunded plans to
healthy companies with well-funded plans.
This excessive subsidization extends across industry sectors--to
date, the steel and airline industries have accounted for more than 70
percent of PBGC's claims by dollar amount while covering less than 5
percent of the insured base.
The PBGC also needs better tools to carry out its statutory
responsibilities in an effective way and to protect its ability to pay
benefits by shielding itself from unreasonable costs. Recent events
have demonstrated that the agency's ability to protect the interests of
beneficiaries and premium payers is extremely limited. This is
especially true when a plan sponsor enters bankruptcy or provides plant
shutdown benefits--benefits triggered by a plant closing or other
condition that are generally not funded until the event occurs.
Currently, the agency has few tools at its disposal other than to move
to terminate plans in order to protect the program against further
losses.
The Bush Administration's Proposal
The Administration's proposal would reform the PBGC's premium
structure. The flat per-participant premium will be immediately
adjusted to $30 initially to reflect the growth in worker wages since
1991, when the current $19 figure was set in law. This recognizes the
fact that the benefit guarantee continued to grow with wages during
this period, even as the premium was frozen. Going forward, the flat
rate premium will be indexed for wage growth.
In addition to the flat-rate premium, a risk-based premium will be
charged based on the gap between a plan's funding target and its
assets. Because the funding target takes account of the sponsor's
financial condition, tying the risk based premium to the funding
shortfall effectively adjusts the premium for both the degree of
underfunding and the risk of termination. All underfunded plans would
pay the risk based premium. The PBGC Board--which consists of the
Secretaries of Labor, Treasury and Commerce--would be given the ability
to adjust the risk-based premium rate periodically so that premium
revenue is sufficient to cover expected losses and improve PBGC's
financial condition. Charging underfunded plans more gives employers an
additional incentive to fully fund their pension promises.
As part of improving PBGC's financial condition, additional reforms
are needed. Plan sponsor bankruptcies and plant shutdown benefits
increase the probability of plan terminations and impose unreasonable
costs on the PBGC. The proposal would freeze the PBGC guarantee limit
when a company enters bankruptcy and allow the perfection of liens
during bankruptcy by the PBGC for missed required pension
contributions. The proposal also would prospectively eliminate the
guarantee of certain unfunded contingent liability benefits, such as
shutdown benefits, and prohibit such benefits under pension plans.
Conclusion
The Bush Administration is committed to working with Congress to
ensure that the defined benefit pension reforms included with the
President's Budget--strengthening the funding rules, improving
disclosure, and reforming premiums--are enacted into law.
As I noted earlier, the primary goals of the Administration's
proposal are to improve pension security for workers and retirees, to
stabilize the defined benefit pension system, and to avoid a taxpayer
bailout of the PBGC. This can be achieved by strengthening the
financial integrity of the single-employer defined benefit system and
making sure that pension promises made are promises kept. We look
forward to working with Members of this Committee to achieve greater
retirement security for the millions of Americans who depend on defined
benefit plans.
______
Chairman Boehner. I want to thank all three of you for
coming today, and I congratulate the administration for their
comprehensive proposal on single-employer defined benefit plan
rules changes.
I think all of us know that over the last several decades,
we've patched the system, we've plugged it, we've played with
it, and the fact is it's time for a serious broad view of all
of the rules, and I think the administration's proposal does
that, not that I agree with every part of it.
Mr. Belt, the President's 2006 budget proposal provides for
a complete elimination of the PBGC's deficit over the next 10
years, and since PBGC may not actually assume all those
liabilities in the next 10 years, and quite frankly, will not
assume all those liabilities in the next 10 years, is it
appropriate to require a complete elimination of all of this
debt over what I would call a relatively short period of time.
Mr. Belt. Mr. Chairman, that was, as you noted, the
assumption used by OMB in its--in presenting the President's
budget proposal.
I think it's important to understand that Congress has
mandated that PBGC be self-financing by law, and our only
source of revenues to cover expected claims is premiums.
Heretofore, that has been wholly inadequate. We've averaged
historically about a billion dollars in premium revenue a year.
That's both the flat rate and the variable rate premium.
But as I noted, our deficit position has swung by $30
billion in just the last 3 years, so obviously, that billion
dollars is insufficient going forward. That's not a sustainable
business model, as it were.
Then the question ultimately becomes, who pays for that?
The OMB used an assumption that that deficit would be
amortized over a 10-year timeframe and would cover expected
future claims.
If premiums aren't set at a level, like any insurance
system is set, to have premiums cover expected future claims,
then the question does become, and it's a policy question for
Congress, who pays for those losses?
Chairman Boehner. The PBGC's deficit includes probable
claims that the agency expects to assume in the future.
Can you tell me what the average time is for a probable
claim before it becomes an actual claim on the PBGC?
Mr. Belt. It varies from year to year in economic cycle,
but what I can tell you is, over time, 87 percent of claims
that are booked as probable do become actual losses, and I
would note that about half the companies that we booked as
probable at the end of this last fiscal year have already come
in as actual claims.
Chairman Boehner. The administration's funding proposal, as
I look at it, could potentially cause an investment-grade
company with lower credit ratings to be downgraded to below
investment grade.
Do you share this concern, Mr. Warshawsky?
Mr. Warshawsky. Mr. Chairman, we do not share that concern.
Our understanding is that the credit rating agencies
currently have been focusing on the liabilities, the pension
liabilities that companies have taken, that they have taken
freely, and that are part of their cost of doing business, and
although we believe that the calculation liability that we have
put forward will more accurately represent the liability, it
doesn't change the liability. The liability is there and the
credit rating agencies are increasingly focusing on it.
So per se, we do not believe that will have an impact on
the credit rating.
Mr. Belt. And under current law, Mr. Chairman, a number of
companies, about 30 or 40, have actually been downgraded
because of their under-funding in their pension plans.
I actually think it may work the other way, that the
markets would reward companies for enhancing their funded
status.
Chairman Boehner. Mr. Warshawsky, if we were to enact the
administration's 2006 budget proposal to include a 50-plus
percent increase in flat rate premiums, and do so in 1 year, in
one jump, what do you think the reaction of employers would be?
Terminate plans, freeze plans, begin the process of moving out
of defined benefit plans?
Mr. Warshawsky. I don't think so. These plans are--many
plans are the result of collective bargaining agreements, and
these plans represent benefits which are highly valued by
employees, and rightfully so.
So I think employers will want to fund the benefits and I
think the premium increase would not cause them to terminate
the plan.
Mr. Belt. Mr. Chairman, if I might put it in perspective,
for a company like United Airlines, which may present the PBGC
with a $6 billion claim, they currently pay about $2 million a
year in premiums. This would represent an increase of about a
million dollars a year in premium revenues, and I can tell you
they're spending that much and more litigating against us each
month in bankruptcy court, trying to avoid--trying to be able
to put that $6 billion claim to the PBGC.
So it's actually a fairly modest increase relative to the
liabilities and obligations that are out there.
Chairman Boehner. Ms. Combs, under the administration's
proposal, the yield curve is used to determine lump sum
distributions.
Can you explain to the Committee how this would work?
Ms. Combs. Under current law, there's--as you know, the
Congress last spring passed a substitute for the thirty-year
Treasury over the long-term corporate bond, but there's now a
disconnect between the rate that's applied to lump sums and the
rate that's used for funding, and that actually creates an
economic incentive for people to take lump sums and cash out of
their plans.
We think the same rate should be applied for funding
purposes, for all purposes--for funding, for calculating lump
sums, for paying premiums.
Again, we believe it's an accurate measurement of what the
liabilities are, and that people--it should be a neutral
decision. The interest rate shouldn't determine whether you
decide to take your benefit as a lump sum or as an annuity.
Chairman Boehner. My time has expired.
The Chair recognizes the gentleman from California, Mr.
Miller.
Mr. Miller. Thank you very much, Mr. Chairman.
In my opening statement, I mentioned that I have some
concerns along some of the questions that you raised, Mr.
Chairman, on the allocation of the variable rate and the impact
on that, but I think I'd prefer to pursue that in writing, if
we might.
I'd like to turn to another subject, and that subject is,
Mr. Belt, in your statement, you talk about transparency, and
you say that the funding and disclosure rules seem intended to
obfuscate economic reality, and certainly their effect is to
shield relevant information regarding the funding status of
plans from participants, investors, and even regulators.
That sounds like a fairly successful obfuscation, if all
three of those parties are not there, or don't have the
transparency, and I'd like to ask a couple of questions about
that.
First of all, it seems to me that in these companies, and
the determinations on how they fund their pensions, there's
apparently a whole litany of reasons why you would fund or not
choose to fund your pension plans and when you would make that
determination and what amount.
Some of it has to do with tax law, some of it has to do
with the appearance of the corporate bottom line, some of it
has to do with stock prices, some of it has to do with stock
options, all of which can influence whether or not a company
makes a decision.
But apparently, many of those decisions can be made, and
the outcome in those decisions are hidden from the participants
in the plan, the beneficiaries, if you will, and from the
investing public, and apparently from the regulators for a
considerable period of time.
Is that fairly accurate, Mr. Belt?
Mr. Belt. We are concerned, the administration is very
concerned that not enough relevant, material, and timely
information is provided to participants, who clearly need that
information to make informed decisions about their own
retirement security.
It's also true that not enough information is provided to
the marketplace, to shareholders of companies, particularly
publicly traded companies, whose impact on the company can be
very substantial with respect to what's happening in the
pension plan.
So the administration's proposal is to shed a little
sunlight on the whole issue of pension funding so that all the
various stakeholders have relevant, timely information so they
can make these decisions on an informed basis, which isn't the
case under current law, and that's a problem not only in ERISA,
and we're addressing the ERISA portion of that, but there are
also issues with respect to the accounting standards; and my
understanding is the Financial Accounting Standards Board is
looking at those issues, as well.
Mr. Miller. Well, I'm encouraged that the administration
has put forth these efforts to improve the transparency.
We're telling the American worker and American families
that they have to take more and more control over their
retirement security, and the knowledge of the jeopardy of the
retirement plan that you're currently included in may have a
great deal of influence on decisions that you would make as a
family.
You may want to continue to work for that employer, even
though that plan looks like it's in jeopardy, but you also may
want to increase your private savings or you may want to think
about other changes that your family can make.
And what you have now is, you clearly have a conspiracy to
keep the beneficiaries of this plan from having that
information.
If you're an investor in these companies, you may want to
know what their real obligations are, not the obligations they
gave up for the appearances of changing the bottom line or
changing the exercise of stock options, but what the real
impact is on the financial liabilities of this company, and
investors are entitled to that.
In the situation that you describe in these three pages is
really one that we've now found unacceptable in every other
part of the business world. That's why Mr. Spitzer is hauling
people into court, because we have all of these secret
arrangements that keep one interested party from the apparent
conflicts of the other, and we want transparency on that.
In this situation, you're playing with people's life
savings, and in many instances, you're playing with people's
life savings who have very little, very few options to change
them, because they find out about it, as you point out, a great
number of them are quite surprised when they find out when
they're in trustee--the plans that you say you're a trustee
for, they're quite surprised to learn that the plans were
under-funded at all. That's the first notice they had of it.
So I mean, I welcome this, and I hope that these are strong
enough. I suspect that they'll probably be resisted, but
certainly it's the minimum that the investors are entitled to
and that the plan participants are entitled to.
I always find it rather interesting before some of these
companies rush to bankruptcy, the first thing they do is ensure
the pensions and the deferred compensation of their CEOs and
their top-line executives, so that they're outside of
bankruptcy.
So they obviously have notice that things are not on the up
side here, because they rush out and buy an insurance policy
for their golden parachutes.
Well, most employees will not be able to do that. The least
we can do is give them notice of what the actual real and real-
time situation is with respect to their employer's financial
liabilities, the health of that company, and the health of
their pension plan so that they can make some determinations.
And the marketplace is, in fact, a partner with these
pension plans, and it should be a partner with these pension
plans, and there's a certain sanitizing of that, but if this
information can even be held from the marketplace, then it's
not working.
And so I want to thank the administration for spotlighting
those areas that I think are terribly important to a well-
functioning pension security plan, and I plan to pursue this
further both with the administration and with my colleagues in
Congress.
Thank you.
Mr. Johnson [presiding]. You know, it's not often I agree
with--
[Laughter.]
Mr. Miller. You go far enough right, and you'll meet the
guy from the left coming around the other side.
[Laughter.]
Mr. Miller. It's a round world, remember.
Mr. Johnson. Thank God, huh? We'd fall off.
You know, there's much to commend the administration in
coming forward with their proposals, and I applaud the general
approach on moving to risk-based governance of pension plans.
It works pretty well for car insurance, it ought to work better
for pension plans than what we've been using.
That said, I have some questions.
At the joint pension hearings that we held last year
between my Subcommittee and the Ways and Means Subcommittee on
Select Revenues, I had talked with you, Ann Combs, about the
multi-employer pension plan reforms, and you assured me that to
the extent we were going to increase disclosure and funding
rules on single employer plans, we'd also work on similar
reforms on multi-employer plans.
Unfortunately, your proposal contains only single-employer
reforms. Multi-employer plans have never had a premium
increase. There are some real problems in that area. And yet
the administration has made no recommendations regarding these.
How long were you planning to wait before making
suggestions in that arena, and will you follow through on your
assurance that you would work with us to achieve similar
reforms in the multi-employer plans?
Ms. Combs. We are concerned about multi-employer plans as
well, and the workers who participate in them, and our judgment
was, in putting this package together, that the problems facing
the single-employer system are simply much larger in nominal
dollar terms and the problems are more acute.
Workers' benefits in single-employer plans are actually
more at risk than they are in the multi-employer system because
of the way it works.
That being said, there are major problems there, and we do
want to work with Congress and with you, Mr. Johnson, to
address them, and I think we've talked to your staff and
others, and I think been up front about the fact that we wanted
to get the single-employer proposal out into the public space
and begin to debate it. We thought it was important that it not
be held up while we try to figure out how we should deal with
the problems facing multis.
They're very different systems. I think they need different
solutions. And we have begun to think about that internally. We
want to sit down with you, and we hear the message that the
Committee wants to address it as part of this bill, and we will
work with you on that, but we wanted to get this out and in the
debate, out of the way--
Mr. Johnson. Well, but as Mr. Miller points out, disclosure
is the same for both plans, and I don't understand why we can't
at least do that much.
You know, it's the same for multi-employer as it is for
single employer.
Ms. Combs. I think that's true, and I would just note that
you did include some disclosure for multis in the bill that you
passed last spring, and we have issued proposed regulations to
put that into effect.
We are very committed to transparency and disclosure, and
we will work with that.
Mr. Johnson. I appreciate that. Thank you for your
response.
Mr. Belt, you all took over U.S. Air, and I'm wondering,
are you going to do the same thing with United? Because I think
that was a terrible disservice to the airline industry, because
now U.S. Air can set their prices wherever in the heck they
want to without having to worry about funding a pension plan.
Furthermore, the pilots, as you know, receive less, because
of the retirement system the way it's set up, and can you
address that issue.
And are you going to stand firm with United?
Mr. Belt. I would be pleased to do so, Mr. Chairman.
As you know, that's not a decision that's actually made by
the PBGC.
Mr. Johnson. Who makes it?
Mr. Belt. The bankruptcy court judge. Under law, under
ERISA, companies are able to file what is known as a distress
termination application to the bankruptcy court once they're in
Chapter 11.
It is the bankruptcy court that makes the decision as to
whether or not the company would be able to successfully emerge
from Chapter 11 and still maintain its pension plans.
In many cases--in the case of U.S. Airways, and of course
in the case of United--they made it very clear their view is
they have to shed those pension liabilities onto the pension
insurance program in order to successfully emerge.
We do not actually make the decision, but we certainly
engage with the company and with the bankruptcy court.
In the case of U.S. Airways, we concluded, on a good faith
basis, that they met the criteria under the law to turn their
pension plans over to the Pension Benefit Guaranty Corporation,
the criteria established by Congress.
We have not yet reached that decision with respect to
United Airlines. We've publicly indicated that based upon
information that was available a couple of months ago that they
in fact could not afford all four of their pension plans, but
our view was they could afford at least two, perhaps three, but
of course the situation is very much in flux depending on what
happens in the market, depending on what happens with fuel
prices.
Mr. Johnson. OK. I think that you've given them an
advantage by doing that, and perhaps we ought to see if we
can't get you involved in the bankruptcy court. Of course,
that's a different Committee. But somehow you should have more
of an input.
And, you know, as an independent agency, which you are, it
seems to me that you ought to be protecting the dollars of the
citizens and not necessarily doing everything the bankruptcy
court tells you to do. I understand you're under some
constraints there.
But thank you for your comments.
Mr. Kucinich, you're recognized for 5 minutes.
Mr. Kucinich. Thank you very much, Mr. Chairman, Ranking
Member Miller, and Members of the Committee.
The appropriate title of this meeting is ``The Retirement
Security Crisis,'' and I think, as some members have stated
before, we need to look at this in the context of the American
workers' dilemma where their retirement security depends not
only on Social Security, which I believe, you know, the
administration's plan is effectively being dismissed by the
American people, but also on savings.
And you have to keep in mind that savings, right now the
average savings for a worker about 55 years old is about
$10,400, and there has been a decline in seven consecutive
quarters in terms of average savings. It's the first such
decline since 1934.
And to that you add the fact that's been produced today,
that the average pension funding level has declined from 120
percent to approximately 80 percent--now it's going back up to
85--we really need to talk about the retirement security crisis
in its totality.
Now, in my own district--and I want to address these
remarks specifically to Ms. Combs--a group of 19 employees saw
their retirement funds vanish as their employer, the Lakewood
Manufacturing Company, repeatedly dismissed employee requests
for the release of plan documents, for over 5 years.
And for a period of over 5 years, the plan's fiduciary, who
also happened to be the owner of the company, used funds from
the employee pension plan to make dangerous and imprudent
investments in companies in which he had a personal stake.
During this time, the fiduciary failed to file a Form 5500
for three consecutive years.
Only after thorough research by my office, and based on
employee complaints, did the Department of Labor finally
investigate the plan in late 2001, but by then the damage was
done. The company's most recent 5500 filing in 1998 reported
pension investments totaling over 1.9 million and by 2001, all
of the money was gone; and had the fact that Lakewood did not
file the required 5500 form in 1999 been flagged by the DOL,
most of the workers' retirement money might have been saved.
So I'm glad to hear that the Department of Labor agrees
that it's necessary to shorten the time plans are given to file
5500 forms. I'm concerned that this new due date would not
include plans with less than 100 participants.
And, you know, we're all here advocates of small business,
but we also ought to be advocates of employees of small
businesses, and with plans with less than 100 participants not
being covered, there's a question here.
Further, I'm concerned that the benefits of this
improvement in filing time will be lost by inaction on the part
of the Department of Labor when companies fail to file at all.
So, you know, I would contend, and I'd be happy to hear
your response in a moment, that the practice of filing the 5500
form suffers from serious inefficiencies. Why should workers in
smaller plans and companies be excluded from the protections
that 5500 forms are supposed to offer, and a company that
intentionally fails to file at all faces no consequences, at
least with respect to labor.
How effective can the Department of Labor be in protecting
employee pension assets with such lax reporting requirements,
and if a 5500 is not filed, you know, what authority does the
Department of Labor have now to compel filing, such as freezing
the assets of a plan fiduciary until the form is submitted?
And I'd be very appreciative of hearing whether or not
you're going to come to Congress for that authority and what
you're prepared to do to protect those millions of Americans
who work in companies that are smaller than 100 employees.
Ms. Combs. Right. You raise some very important issues.
The proposal to exclude plans with fewer than 100
participants is from the requirement to file the accelerated
actuarial information only, that's the carve-out, and that was
a balance we tried to strike because of the burden it can place
on small plans to have to do estimated actuarial valuations in
advance.
Small plans do have to file the 5500. There's not a carve-
out for them. And we do have the authority to impose civil
penalties on people who either file late or who don't file at
all.
I will tell you it is difficult to find people who never
file at all. We do have a system in place where if people stop
filing, we go and we check and see why they stopped filing, and
often the plan may be terminated or there may be a reason. But
if someone never starts to file, it's hard to get them on our
radar screen.
We do have now a new position throughout the country. We
have what are called benefit advisors. We have 110 folks around
the country who--and we're trying to advertise our 800 number,
essentially our toll-free number, to get people to call us and
tell us when they see discrepancies.
That's the best source we have for investigations to go in
and see if there's a problem, and I'm sorry it took so long for
us to become aware of this problem.
We've also been doing an outreach with congressional
offices, because we know people often call their Member of
Congress, and so we want to make your offices aware of our
services, as well.
But we do have an enforcement program that focuses on the
filing of the 5500. We do impose substantial civil penalties,
up to $1,000 a day, for the failure to file or for filing late
or incomplete 5500's, and we have an office of chief accountant
who has a program to enforce that, and we'll be happy to come
explain it, and if it needs to be--if you'd like to talk about
additional remedies, we'd be happy to talk to you about them.
Chairman Boehner. The gentleman's time has expired.
Mr. Kucinich. But what I don't understand, if the
gentlelady is saying that this new date is going to include
plans for those with less than 100 participants?
Ms. Combs. Plans with less than 100 participants do have to
file a 5500, and our proposal does not change that.
What we have said is, plans that have more than 100 now
have to file the Schedule B, which is the actuarial information
that's attached to the form earlier, much earlier, but the
small plans we did carve out because of the administrative
burden in trying to balance that cost-benefit analysis.
Mr. Kucinich. That's what we need to talk about, Mr.
Chairman. Thank you.
Ms. Combs. OK.
Chairman Boehner. The Chair recognizes the gentleman from
Minnesota, Mr. Kline.
Mr. Kline. Thank you, Mr. Chairman.
I thank the witnesses for being here today and I'll add my
apologies to those, I'm sure, of many of my colleagues. As
we're moving back and forth between hearings sometimes we miss
a piece of your testimony or the answer to a question, so I may
cover some familiar ground--familiar to you, but not
necessarily to me.
I want to identify myself with the remarks of Mr. Johnson
about the multi-employer plans, Ms. Combs. I understand that in
terms of total dollars, if you will, that it's not the same
magnitude, and yet we know we've had testimony in hearings in
this Committee that there are multi-employer plans--Central
States comes to mind right away--that are facing some serious
problems, and I think we do need to address those, and I hope
that my colleagues and I will address it as we move forward to
address the retirement security crisis.
I wish that the administration had included that.
I also way to identify myself with his remarks, Mr.
Johnson's remarks, about the airlines.
We had--by U.S. Airways going into bankruptcy, it's gained
a competitive advantage with other airlines, and not a secret
to those of you who have maps and see where airlines are
headquartered, I've got the headquarters of a large airline,
Northwest Airlines, in my district, and I'm very concerned that
at the end of the day, when we move forward to take action on
the administration's proposal and our proposal, that we have a
policy that protects the retirement benefits of the retirees,
provides some protection for the PBGC, Mr. Belt, but also
doesn't force other companies into bankruptcy, and I'm not sure
that we're there yet with the administration's proposal and the
legislation as it moves forward.
We've made some changes in the President's proposal with
interest rates, talking about yield curve instead of Treasury,
and there's an issue of smoothing.
I wonder, I don't know if--Mr. Warshawsky, I think this is
in you our particular bailiwick.
Could you, just for my understanding, explain what would
happen if short-term interest rates rise and long-term rates
fall, what are the consequences for employers with respect to
how much they would have to contribute? What effect would that
have?
Mr. Warshawsky. Well, first let me say, and actually in a
way it's--I want to respond to something that Mr. Miller said,
that the point of the yield curve and the other reforms in
terms of the measurement of pension liability is to get a
timely and accurate--accurate in the sense of current--measure
of the plan's funding status. That's what is, what really is
appropriate for the funding target; that's what is appropriate
for the plan participants to know, and that is the goal of our
reform.
Congressman, with regard to your specific question about
the shape of the yield curve, it is very rare to have what I
would say you're referring to, which is an inverted yield
curve, where short rates are higher than long rates.
That's a very rare occurrence, particularly in the
corporate market. It occasionally occurs in the Treasury
market, is an extremely rare occurrence in the corporate bond
market.
Mr. Kline. So we can disregard it?
Mr. Warshawsky. I think largely it can be disregarded.
Mr. Kline. Unless it happens, of course.
[Laughter.]
Mr. Warshawsky. We only have the historical record to work
with.
Mr. Kline. Yes, sir, I understand.
Could we talk about the smoothing issue? I understand in
the administration's proposal that you're talking about
smoothing over 90 days, which is a quarter. Why is this more
accurate, and why is this better, and why does this work better
for planning purposes for those who are maintaining these
plans?
Mr. Warshawsky. Clearly, this is--I think we've used the
term ``a balance,'' and there's a balance here as well.
One could go to the end of the spectrum, where you
basically have the plan measured on a date, December 31st of
the end of the year.
We felt as if there is some noise in bond markets and
interest rates, which generally, experience seems to indicate
that takes a month or two to work out, and therefore we
choose--chose a 90-day smoothing mechanism, actually, it's 90
business days, so it's actually more like four-and-a-half
months, to account for noise.
Beyond that, however, we felt as if we really lose to much
in the way of the accuracy, which we all agree is very
important for all the purposes, and we didn't want to have more
smoothing, which basically is masking the true status of the
plan.
Mr. Kline. Thank you.
Mr. Chairman, I see my time has expired, and I yield back.
Chairman Boehner. The Chair recognizes the gentleman from
Virginia, Mr. Scott, for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman, and I apologize that I
had to leave, so some of these questions may have already been
addressed.
Mr. Belt, you indicated that some of the firms are having
difficulty with their pension funds because they're in
financial difficulty; is that accurate?
Mr. Belt. It is--PBGC as an insurer becomes most concerned
when you combine under-funding with credit default risk, and so
most of our attention is focusing on those cases where
companies that are in financial difficulty are sponsoring plans
that are well under-funded.
Mr. Scott. Now, is the fund a separate fund? I mean, if the
company goes bankrupt, what happens to its pension fund money?
Mr. Belt. Well, Ann could talk about that. It's a separate
legal entity.
When we trustee, when we take over a pension plan when it
terminates in under-funded status, we actually get the assets
of that pension plan as well as all the liabilities.
Unfortunately, whenever we take over an under-funded plan
,there are many more liabilities than there are assets.
Mr. Scott. Now, this is a trust fund, and the fiduciaries
have a fiduciary responsibility, so they can't dip into the
fund for anything other than paying out benefits; is that
right?
Ms. Combs. That's correct.
Mr. Scott. And if they do dip into it for something else,
has a crime been committed?
Ms. Combs. I'm sorry? There's a violation of the law. It's
a fiduciary responsibility to not use it for anything other
than to pay benefits and reasonable expenses.
Mr. Scott. And if people are dipping into it, I mean, are
they prosecuted?
Ms. Combs. Yes, they are. We had over 4,000 cases last
year, civil and criminal.
Mr. Scott. Now, to determine whether or not the thing is
solvent or not, what rate of return do you assume to determine
whether or not a plan is solvent?
Mr. Belt. The issue is not whether it's solvent as such.
The question is whether the pension plan is terminated for any
of a variety of reasons.
We discussed earlier the situation that arises, for
example, in the airline situations, where they're seeking to
terminate their pension plan, saying that they cannot afford
them and stay in business.
The decision then becomes how do you value those
liabilities when the pension plan is terminated? And we use a
market-based mechanism, what private insurers would charge to
do annuities for somebody who did a standard termination of a
fully funded plan.
Mr. Scott. And if you look and find that it is under-funded
because the stock market went down or something like that, then
what action is taken?
Mr. Belt. Well, as I indicated, we have--we take over the
assets in that pension plan, but there's a big gap there.
The company is notionally liable for all of the difference
under law. However, our historical experience in trying to
recover on our claim in bankruptcy has been that we get about
seven cents on the dollar.
Mr. Scott. How did it get so under-funded, I mean, if
people are watching?
Mr. Belt. That's an excellent question, and a variety of
factors have caused pension plans in many cases to get under-
funded.
Much of what we've been talking about has been mechanisms
in current law that really have enabled this to happen. It was
a combination of marketplace factors.
There were some falling asset prices between 1999 and 2003.
Interest rates were coming down, which caused an increase in
the value of the liabilities.
At the same time, because companies had put in extra monies
in their earlier years, they were able to take advantage of
contribution holidays, credit balances, so that in fact, at the
same time that asset prices were falling and interest rates
were falling and the liability was widening, they were putting
no money into the pension plan.
They continued to have to pay out benefits, which further
drained assets. Liabilities continued to accrue. So the gap
widened and widened and widened.
A recent study by Credit Suisse First Boston noted that
between 1999 and 2003, for the system as a whole, for the S&P
500, assets grew by a total of $10 billion, less than 1 percent
per year compound annual growth rate, while liabilities grew by
$430 billion during that period of time, a 10 percent annual
compound growth rate.
Mr. Scott. OK. Now, you said all this started in 1999 to
2003. How about around 2000 or 2001? Didn't somebody notice
that more contributions needed to go in?
Mr. Belt. Well, that's where we get into the issues of
credit balance and smoothing.
The current system unfortunately hides what's happening in
the pension plan, and there were a couple of charts in my
testimony, in my written testimony, showing examples with a
couple plans we've taken over, U.S. Airways and Bethlehem
Steel, that noted that on a current liability basis, they were
telling us, they were telling participants that they were 90-
plus percent funded, while on a termination basis, which became
more and more relevant as their financial condition
deteriorated, they were perhaps only 50 percent funded, and
they were not required to pay any variable rate premium, they
were not required to pay--to provide a notice to participants
regarding their funded status, and in many cases, they were not
making any contributions to the pension plan.
Mr. Scott. Mr. Chairman, let me just ask one quick--were
they telling the truth?
Mr. Belt. They were fully complying with current law, which
is part of the problem.
Chairman Boehner. The Chair recognizes the gentleman from
Georgia, Mr. Price, for 5 minutes.
Mr. Price. Thank you, Mr. Chairman.
I do appreciate the testimony, and I also appreciate the
administration's desire to address what I think is a huge,
looming problem, and I hear from some of my constituents to
that effect, as well.
I'd like to step back, though, a little bit and kind of
follow up on what Mr. Scott was talking about, and try to
understand how we got to where we are right now.
It looks like the folks that ought to be minding the store
weren't minding the store, and I guess I need--I want to step
back and get a perspective from each of you, if you have
thoughts about it, kind of following up on where Mr. Belt was,
about how we ended up--how did we get to this point right here?
What's the fundamental problem that resulted in where we are?
Ms. Combs. Well, I think as Mr. Belt described, I mean, the
recent combination of market forces has put a spotlight on the
problem, but the underlying problem is that the current rules,
the funding rules that we're talking about changing, are
inadequate.
They don't require companies to put enough money in on an
ongoing basis to meet the obligations that they have. They
allow the companies to continue to make benefit promises when
they're at a point when they're very under-funded and they
shouldn't be making additional promises, they haven't funded
the ones that they've already made.
The disclosure is weak, so that people are slow to see the
problem developing and they're unaware that it's beginning to
brew in their plans.
And so that is why we've come up with a comprehensive
proposal, and I agree with the Chairman and the principles he
laid out last year, that this is not a matter of tinkering. The
system is fundamentally broken, and we need to go in and we
need to fix the rules that govern how much money has to be set
aside, the rules that govern how that is communicated to
workers, retirees, people in the marketplace, and we need to
tell people that if they get into a position because of market
forces where their plans are severely under-funded, and
particularly when the company sponsoring it is financially weak
and has other demands, that they need to stop making additional
benefit promises.
So we think our proposal addresses it.
I'd say the current market situation has really just put a
spotlight on the fact that the rules are too weak.
Mr. Price. You believe that the recommendations from the
administration address across the board the problems that
resulted in where we are right now?
Ms. Combs. Yes, I do.
Mr. Warshawsky. Congressman, if I might add, from a bit of
a historical perspective and even a personal perspective, I
used to work at the Internal Revenue Service, more than 10
years ago, in the employee plans division, and the IRS, along
with the Department of Labor, is responsible for enforcing the
minimum funding requirements.
And when I was there, we did an examination program to be
sure that plan sponsors were following the law, because it
could be that the problem was that they weren't following the
law, and that was the source of the problem then, which was
more than 10 years ago.
Our examination and study indicated that the problem
largely was not a problem of compliance with the law, but it
was a problem with the law itself, and we believe the same is
true now, and therefore we have put forward our proposal.
Mr. Price. Thank you.
Mr. Belt, I want to ask you a specific question, though.
You mentioned in response to a previous question that the
current system hides the health status, if you will, of a plan.
Do you believe that this corrects that, the ability to hide
that status?
Mr. Warshawsky. We believe very strongly that it does.
And the current system hides the health status of the plan
both on the asset side and on the liability side.
Current law allows something called actuarial value, which
is again a smoothing mechanism for the value of assets which
could--there could be as much as a 20 percent difference in the
value between actuarial value and market value, and then it
certainly does on the liability side, as well.
We believe that our proposal will give a much, much clearer
and accurate measure on both the asset and liability side.
Mr. Price. Let me follow up on another question that was
asked earlier about the bankruptcy court being the ones that
determine whether or not y'all have to take over the plan.
Is there a problem there that needs to be addressed, as
well?
Mr. Belt. That's obviously a policy decision that Congress
would need to make.
Mr. Price. Do you believe there's a problem there that
needs to be addressed?
Mr. Belt. All I can say, Congressman, is what happens under
current law is that the bankruptcy court makes its decision.
The bankruptcy court's judges' interests are aligned typically
with the debtor, the company, because they're trying to get the
company to emerge successfully.
The bankruptcy judge makes that determination on
affordability. We provide information to the bankruptcy court
regarding our analysis of whether they've met the distress
criteria.
The bankruptcy court can choose to accept our analysis or
not. He may agree with our analysis. He may agree with the
company's analysis.
Our experience has been that we don't do very well in
bankruptcy court.
Mr. Price. Thank you.
Thank you, Mr. Chairman.
Chairman Boehner. The Chair recognizes the gentleman from
New Jersey, Mr. Andrews.
Mr. Andrews. Thank you, Mr. Chairman.
I thank the witnesses for their testimony and I apologize
for not being personally present when you gave your testimony,
but I did have a chance to read it, and I appreciate what
you've done.
I think we share a healthy bias, and that bias is in favor
of the retention and growth of defined benefit plans. I think
it's good for the economy. I think it's good for the
individuals who participate, good for the employers.
I also think that the most effective means to solve the
PBGC crisis is to make sure we still have plenty of premium
payers, meaning plenty of people sponsoring defined benefit
plans.
I personally also share your proposal that in good times we
should lift the artificially low contribution limits that
exist, I think solely for revenue reasons, and I think when
good times occur, that we should encourage employers to put
more away and make those contributions fully deductible.
It is with that concept in mind that I do have some
concerns about the yield curve proposal with respect to the
interest rates.
I think that your inclination to simplify interest rates by
having one interest rate apply to all calculations is
conceptually a good one, but I do have a real concern about the
complexity we're adding to the system through the yield curve
calculation.
I think that the litmus test that we should apply for any
of these proposed changes is whether they make the retention
and growth of defined benefit plans more likely or less likely.
I think it is a general rule of thumb that uncertainty
makes these plans less likely. Corporate decisionmakers living
in an extremely volatile world, where they are judged each
quarter, maybe even each week by their financial performance,
make these decisionmakers reject uncertainty. The more
uncertain something is, the less likely they're going to do it;
and there's a massive uncertainty, I think, built into an
interest rate calculation that depends upon variable factors.
Your approach is theoretically elegant, because it does
measure how many people are going to be receiving benefits how
soon, and that is a more precise and elegant measure of what we
want to do, but I think that that measure has negative
consequences for corporate decisionmakers.
For example, if I were a CEO and I decided to try to pare
my workforce by encouraging an early retirement plan where I
gave early retirement bonuses in a big hurry. That has profound
consequences for my retirement fund and it also has profound
consequences for my future workforce. Merger and acquisition
decisions, spinoff decisions are affected by this.
The premise that one's workforce is relatively constant in
age and in liberality of benefit I think is not correct. I
think that the age of your workforce changes as you implement
these strategies, and the liberality of your benefit may change
as you have different business units handling different
employees.
So I'm not prepared this morning to say that I think the
yield curve is a terrible idea and we shouldn't do it, but tell
me why it doesn't add more uncertainty to a corporate
decisionmaker's look at a DB plan.
Tell me why a corporate decisionmaker isn't going to look
at this and say, ``Oh, my goodness. Here's one more set of
variables that I cannot control that make this defined benefit
plan too unwieldy, too much of a risk, and let's just kick it
all over to a defined contribution plan and get out of this.''
Why is that not true?
Mr. Warshawsky. Congressman, I'll mention a few things, but
probably the most important item is that we believe that our
proposal, taken as a whole--and the yield curve is just part of
it, it's an important part, but it really has to be viewed in
the context of the whole proposal--is that we actually are
providing tools to plan sponsors to manage that uncertainty and
those risks.
I think you have indicated that the ability to advance
fund, pre-fund in good times is a very important aspect of the
proposal that enables plan sponsors to manage that risk and
manage that uncertainty.
Also, our 7-year amortization is a liberalization of
current law compared to periods which are as short as 4 years
under current law.
And it also is within the plan sponsor's purview, and it's
a matter of its risk tolerance as to the asset allocation that
it would want to choose.
I would also indicate that we appreciate the comment that
it's elegant. We think it's elegant, as well. But clearly, this
is--
Mr. Andrews. I meant that in a technical sense, the way
Alan Greenspan means ``elegant.''
[Laughter.]
Mr. Andrews. Because, you know, you can dress a pig up, and
it still is a pig.
Mr. Warshawsky. I would say that, but at the same time,
this is a practical proposal, because yield curves are very
commonly used in a lot of other applications in finance and
corporations and in mortgages, even in common banking
procedures in terms of different rates for different maturities
of certificates of deposit.
We think that this is actually a very, not a burdensome
calculation at all. It can be done on a spreadsheet.
Mr. Andrews. I appreciate that. I see my time is up.
I would just add, though, that my concern is that, by
necessity, corporate decisionmakers must change the shape and
age of their workforce constantly, and as that changes, so do
the underlying factors in the formula, which means so does the
formula, which means so do your obligations, which gives you
more volatility. That's my concern.
Thank you.
Chairman Boehner. The Chair recognizes the gentleman from
New Jersey.
Ms. Combs, would you like to comment?
Ms. Combs. No. I'm just looking for the gentleman from New
Jersey.
[Laughter.]
Chairman Boehner. The Chair recognizes the gentleman from
New Jersey, Mr. Holt, for 5 minutes.
Mr. Holt. As the other gentleman from New Jersey, I would
like to associate myself with the comments and questions of the
gentleman from New Jersey behind me, and also with the
questions from the gentleman from Ohio about why smaller
companies--employees at smaller companies shouldn't have the
same guarantee.
I just wanted to deal with one aspect of this, which has to
do with the tax benefits that come to an employer, and I want
to make sure that, as we encourage better planning for better
funding, we're not allowing companies to use the funds for
other purposes, for unrelated purposes.
And I just wanted to probe the witnesses to get your idea
of why you think what's written in here provides adequate
protection.
Ms. Combs, you've made it clear, with more than 4,000
prosecutions, civil and criminal, a year, you take it seriously
and you let employers know that you take seriously any misuse
of funds, but there are a number of clever--yes, even elegant--
ways that corporations have found to use these funds that's not
actually criminal, but it seems to be for purposes other than
maintaining the viability of people's retirement.
So I'd like to hear you elaborate on some of what you've
said already about why you think the protections for devoting
funds to unrelated purposes are good enough.
Ms. Combs. The law is pretty absolute. The funds that are
set aside and held in trust, they have to be segregated from
the corporate assets and held in a separate legal trust, are
there solely for the benefit of the workers and the retirees in
that plan.
Mr. Holt. Let me just say, though, part of what I think
makes it possible for them to do this are the tax deductions
they get for the larger plan contributions and so forth.
Ms. Combs. There were situations back in the 1980's where
companies were terminating plans and taking out excess assets
and then reestablishing them. That has been effectively
eliminated. There is now a 50 percent excise tax on any excess
assets that are recovered from a terminated plan that has more
than enough assets to meet its obligations, so that is--that no
longer occurs.
There are rules against using the plan assets for the
interest of the employer, the so-called prohibited transaction
rules. You cannot use the assets for the benefit of the
employer or deal with it in a self-dealing fashion.
The only real exception to being able to use excess assets
for another purpose is in the tax code, which is if a plan is
more than 125 percent funded, it can use, take out assets to
pay for retiree medical benefits, but only enough to pay for
the retiree medical benefits that are owed that year.
That is really the only exception. It's very limited, and
the law is strictly enforced, as you said.
Mr. Holt. Would either of the other witnesses care to
comment?
[No response.]
Mr. Holt. All right. I yield back my time.
Chairman Boehner. Would the gentleman yield?
Mr. Holt. Yes, of course.
Chairman Boehner. I think Ms. Combs has adequately
explained assets that go into a defined benefit pension system
are, in fact, I think adequately protected.
The problem we have under the current rules is are there
situations where, because they have credit balances that--and
they can use assets in their plan, they don't have to mark
those to the market, that people can avoid payments at times,
payments that should have gone into these pension systems?
And if you look at the, we'll take the Bethlehem Steel case
as an example, where in terms of the model, the rules that we
have, it looked like they were in decent shape, but when you
took away the credit balances, when you marked their assets and
liabilities to what were real in the marketplace, they weren't
anywhere close to being funded.
And it's those rules about how we're going to view the
assets, those rules about how we're going to deal with credit
balances, and what the effective discount rate should be that
will prevent plan sponsors from getting themselves in any more
serious trouble than some have already done.
Mr. Holt. Yes, Mr. Chairman, and I just want to make sure
that as we put in place methods to encourage companies to fully
fund these plans and keep them up, that we're not rewarding
diversion of funds for other purposes, so that it really will
be used to ensure the financial stability and security of the
plans.
So thank you very much, Mr. Chairman.
Chairman Boehner. The Chair recognizes the gentlelady from
Illinois, Mrs. Biggert.
Mrs. Biggert. Thank you, Mr. Chairman.
In the administration's proposal, companies with at-risk
plans that fund their plans at 40 percent or below cannot
increase benefits or credit future accruals to employees, and I
think I agree with this, but why is this not extended to the
company executives?
Ms. Combs. That is the situation where we would say if a
company is financially weak and their plan is less than 60
percent funded, the plan would be frozen and the non-qualified
executive compensation could also not be secured. They could
not use corporate assets to fund their own executive
compensation.
If they did, the pension plan would have a right of action
to recover that money and have it put into the pension plan.
So we have proposed kind of the what's good for the top
floor is good for the shop floor rule.
Mrs. Biggert. OK. Then why do you think that Congress's
role of setting risk-based premiums should be transferred to
the PBGC board?
You know, we hate to lose power, I guess.
[Laughter.]
Mr. Belt. Well, it comes back to a point I had made
earlier, that in any financially viable insurance system,
premiums need to be set at a level and periodically adjusted to
be able to cover expected claims. That has not been the case in
the pension insurance program.
Congress did set the level of premiums, but the last time
they did so was in 1994, eleven years ago, and premiums have
not adjusted since then, notwithstanding the fact that we've
had substantially greater period of claims, higher claims over
the last few years.
So again, as I noted earlier, historically, we've derived
about a billion dollars a year in premium revenue. Yet, just
over the last 3 years, our net position has deteriorated by $30
billion.
So obviously, there's a disconnect in what premium levels
have been and it's an unusual premium environment where premium
payers are able to go for 14 years without any premium
increase. I wish I could say the same thing about my
homeowner's insurance or health-care insurance and anything
else.
And so that's the reason to give the flexibility to the
PBGC board, which is in the best position to respond
appropriately to marketplace developments, and I would note
that the FDIC, another Federal insurer, has similar type of
premium setting authority.
Mrs. Biggert. Thank you. I apologize for not being here
before to hear that, but I thank you for your answer.
I would yield back.
Chairman Boehner. The Chair recognizes the gentleman from
Massachusetts, Mr. Tierney, for 5 minutes.
Mr. Tierney. Thank you, Mr. Chairman.
I thank the members of the panel.
We've seen discussed, or heard discussed here this morning,
the yield curve and the fact that it's based on the notion of
matching--of the company's funding liabilities with the age of
the workforce or the duration of the plan.
In absence of that yield curve or even as a complementary
approach to it, is there even more that we can be doing to
ensure that the company's investment decisions are more closely
matched to the plan's duration?
Mr. Warshawsky. Congressman, we feel as if it's not the
position of the government, whether through the PBGC or through
any other agencies or in the rules to tell companies how to--
what assets to select.
Mr. Tierney. If I can interrupt you for 1 second and have a
little dialog here, I don't mean to be rude, but isn't that in
essence what you're trying to do a little bit with the yield
curve, not tell them so much, but lead them?
Mr. Warshawsky. We feel as if we're giving the company's
plan sponsors the tools to manage the uncertainty and the risk.
Certainly asset allocation is one tool that they can use,
but there are other tools that we are giving them.
Mr. Tierney. So is that a yes? I mean, I just--
Mr. Warshawsky. I would say it's a no, actually.
Mr. Tierney. It's a no?
Mr. Warshawsky. Meaning I would say that it's really
something that we don't know what plan sponsors will do. We
hope Congress will--
Mr. Tierney. Well, why did you do it if you don't know what
they're going to do? What was the purpose of using the yield
curve if you don't know what the results will be?
Mr. Warshawsky. The purpose of using the yield curve is to
get the most accurate measurement of the liability that we can.
Mr. Tierney. You do that without any consideration of what
effect it might have in terms of encouraging investors one way
or the other; is that what you're saying?
Mr. Warshawsky. As I say, we feel as if it's most important
to get accuracy for the plan participants for the government
agency, for investors.
Mr. Tierney. Right, and did you do it without any
consideration at all for what effect it may have?
Mr. Warshawsky. No, we certainly have done extensive
modeling of the proposal.
Mr. Tierney. And as a result of that, what do you think
using that yield curve will do in terms of affecting the
investments made?
Mr. Warshawsky. With regard to investments made, we really
do not know, because it has to be done in the environment of
the entire proposal.
Mr. Tierney. So you did no modeling on that?
Mr. Warshawsky. No, we did not.
Mr. Tierney. OK. And you did not have any intentions of
affecting it one way or the other?
Mr. Warshawsky. That was not top of mind in our
considerations.
Mr. Belt. Congressman, if I might add to that?
Mr. Tierney. Please do.
Mr. Belt. I mean, one of the--our position was that that's
a business decision to be made by the CFO and CEO, just as they
do with an airline company trying to figure out where fuel
prices are going to be.
Some decide to bear that risk and not hedge their fuel
prices and just figure out they'll buy fuel, whatever the price
is down the road. Some of them try to manage that.
Same thing with the car companies that don't know where
steel prices are going to be or financial services firms that
have to deal with interest rate risk, market risk, and currency
risk. Those risks are inherent in the system.
It's the business decision of the company as to how best to
manage that risk, and it's the decision of the shareholders. We
don't want to dictate that.
But there's no question that, as with all of these risks,
companies should be paying attention to what the risks are on
both the asset and liability side, and making an informed
decision.
Mr. Tierney. Well, I would hope. I mean, you know, it's the
employees that are going to take it in the neck if they don't,
and I think history shows us that those that heavily invest in
equities end up having more difficulty with their pension plans
than those that maybe are a little more heavily invested in
some more secure and stable vehicles.
So that's why I asked whether or not there's been any sort
of a policy decision here to sort of give an impetus to
companies to go a little bit more on the more stable types of
investments, a little less risky in the long run, so that the
people that are relying on this pension will have a little more
assurance that it might be there.
Mr. Belt. Well, from the prospective insurer, I mean,
that's an issue again, a business decision to be made, but if
the company was not at all a credit risk, it was a very
financially solid company, from our standpoint, I would be less
concerned if they were taking a little bit more risk elsewhere.
Maybe the shareholders think that that's a reasonable
business decision to make. That's a business decision that's
made, not--
Mr. Tierney. Well, I guess it's a business decision to be
made, and the shareholders and all that, but the real
stakeholders in this apparently don't get a say, and I think
that's where you might think that government would step up and
maybe go to bat for them a little bit on some of this.
Let me ask another question if I could, because I'm sort of
intrigued with the idea of the Pension Benefit Guaranty
Corporation having some protection for the pensions rights of
employees if they go into bankruptcy.
But then there's been some pushback by people who, of
course, think that that might discourage the lending community
from extending financing to troubled companies, and in fact
result in more bankruptcies.
Would each of you discuss that a little bit for me, and how
you come down on that, what the considerations are?
Mr. Belt. One part of the administration's proposal is that
PBGC would be able to, in contrast to current law, be able to
enforce a lien in bankruptcy for missed contributions.
We can enforce that lien outside bankruptcy right now. A
lien arises automatically by operation of law under Section 412
in the Internal Revenue Code, and we can enforce that.
We can't in bankruptcy. It's automatically stayed. And that
was the situation that arise with respect to United.
But Mark had alluded to this earlier, and the Chairman had
as well, that ultimately, this is a balancing of interest with
respect to the bankruptcy code or anything else.
Obviously, there are those who would not want PBGC's
position elevated in any way, shape, form, or fashion. My
personal view is that with appropriate changes, such as the
being able to force the lien, you actually create the right
incentives on a go-forward basis that creditors would actually
be having covenants in their debt agreements to encourage
companies, or insist that companies keep their plans fully
funded, because they would not want to have the PBGC have a
seat at the table.
Chairman Boehner. If the gentleman would yield?
Mr. Tierney. I will, certainly.
Chairman Boehner. The gentleman was referring to the return
on bonds versus equities, and if the gentleman would look over
the last 20 years, the last 40 years, the last 80 years,
equities would tend to produce about twice the gains of bonds.
Now, in the short term, any short term window, you could
probably find an example of where that wasn't the case.
Mr. Tierney. Reclaiming my time, just looking it from a
different perspective, looking at the number of plans that have
failed and the fact that they have more heavily invested in
equities than the plans that are more--that have continued to
be stable pension plans, I see it the other way around, but we
can have that argument--
Chairman Boehner. Well, if the gentleman would continue to
yield--
Mr. Tierney. Of course, Mr. Chairman.
[Laughter.]
Chairman Boehner. --most of the plans who have, quote, in
your words, failed, have failed because the employer didn't put
the sufficient funding into the plan and probably because of
business conditions that they may have dealt with in the
marketplace.
Mr. Tierney. That may be partially correct, but some of
them have failed just because they took bad investments at
risky times and over the hill it went, but we can collect all
that. The facts will be shown and the data, and then we can
probably debate it better there.
But I want to thank the witnesses for their contribution
and their answers. Thank you.
Chairman Boehner. And I'd like to thank the witnesses for
their excellent testimony and their willingness to help us
better understand the administration's proposal, and with that,
dismiss the first panel and invite the second panel to come
forward.
Mr. Porter, your microphone is on. You might want to turn
your microphone off.
We want to invite and thank our second panel, thank them
for their patience, and it's my privilege to introduce them.
Our first witness on the second panel will be Mr. Kenneth
Porter. He's the director, corporate insurance and global
benefits financial planning at the DuPont Company.
He's responsible for global property and casualty insurance
risks, and for the worldwide financial planning and actuarial
policy for employee and retiree benefits.
Mr. Porter previously served as chair of the ERISA Industry
Committee and the American Benefits Council.
We will then hear from Mr. Norman Stein, who is the Douglas
Arant Professor of Law at the University of Alabama School of
Law in Tuscaloosa, Alabama.
He has taught law for over twenty years, specializing in
the areas of tax, labor, and employee benefits.
From 1996 to 2004, he was director of Pension Counseling
Clinic, which is supported by the United States Administration
on Aging.
We will then hear from Dr. Janemarie Mulvey, who is the
chief economist of the Employment Policy Foundation, a
nonprofit, nonpartisan economic policy research foundation that
promotes workforce and employment policy.
Dr. Mulvey is a nationally recognized expert on retirement
security issues with over 20 years experience conducting
research in the areas of pensions, health, and long-term care
insurance.
And with that, Mr. Porter, we're anxious to hear your
testimony.
STATEMENT OF KENNETH W. PORTER, DIRECTOR OF CORPORATE INSURANCE
AND GLOBAL BENEFITS FINANCIAL PLANNING, THE DuPONT COMPANY,
WILMINGTON, DE, ON BEHALF OF THE AMERICAN BENEFITS COUNCIL
Mr. Porter. Thank you, Mr. Chairman and Members of the
Committee. Thank you for the opportunity to appear here.
In addition to the things that the Chairman indicated, I
would point out that by profession, I'm an actuary, serve as
the chief actuary of the DuPont Company.
I'm serving as spokesperson today, however, for the
American Benefits Council, and joining the testimony is the
American Council of Life Insurers, Business Roundtable, the
ERISA Industry Committee, National Association of
Manufacturers, and the U.S. Chamber of Commerce.
Mr. Chairman, we commend you and Mr. Johnson and the other
Members of the Committee for your leadership in the defined
benefit pension reform. The six principles that you outlined
last September will serve as an excellent foundation for very
much needed pension reform.
We also commend the administration for stepping outside the
box and proposing sweeping changes to the rules governing
pension funding and pension protection.
The administration's proposals encourage us to challenge
the status quo, and we agree that important changes are needed
soon.
In the end, the rules that we ultimately adopt must reflect
the best possible solution for the long-term health of the
defined benefit system in the United States.
Annual pension contributions for many companies can number
in the hundreds of millions or even billions of dollars. In the
aggregate, private sector plans hold nearly $2 trillion in
assets.
Accordingly, direct or indirect changes to this system can
have a significant impact on the investment markets, on the
economic growth, and job creation.
Not only do we agree that funding rules need to be
strengthened, we also agree that broader, more timely
disclosure to plan participants is needed, and that the
proposals to allow employers to make larger contributions
during good economic times is long overdue.
In addition, we agree that meaningful safeguards should be
considered that would adequately protect the PBGC.
I would add that it is not the government that receives the
liability for these benefits. It's plan sponsors. Ultimately,
it's only the plan sponsors that can support the PBGC's
finances, other than its own investment results.
However, we have serious concerns about certain aspects of
the proposal.
Our primary concerns are that the proposal would
dramatically impair the ability of plan sponsors to predict
pension funding and premium requirements; it would introduce
counterproductive and troubling use of credit ratings; create a
strong disincentive to pre-fund; and exacerbate periods of
economic weakness, causing job losses and intensifying the
downward spiral of companies that experience difficulties in
those times.
We're not simply here to talk about those aspects of the
administration's proposal, however. We believe the American
Benefits Council has developed a very forward-thinking,
progressive set of rules to improve the status of the pension
system. These ideas are set forth in our written statements
that have been submitted for inclusion in the hearing record.
Pension plan funding is a long-term undertaking. Proposals to
tie pension funding to point in time interest rates have a lot
of public appeal when the interest rates are low, like they are
today, but we must face the fact that long-term interest rates
have averaged more than 9 percent over the last 28 years, and
they haven't been as low as they are today in more than 40
years.
It could be more than dangerous to our economy and the
creation of jobs if we were to make precipitous changes to
pension funding rules in response solely to today's unusual
environment.
Spot valuations are neither accurate nor predictable. They
undermine a company's ability to make pension business and
business plans, they undermine a company's ability to meet its
funding obligations.
Moreover, pension plans' liabilities can vary by as much as
15 percent, depending on whether the yield curve is steep,
whether it's flat, or whether it's inverted.
It's very difficult for us as plan sponsors to understand
how the shape of the yield curve over a 90-day period has any
relevance on whether the plan can meet its obligations over the
next 50 years.
One of the stated objectives of the proposal is to
encourage plan sponsors to increase their voluntary funding.
Unfortunately, this is not always the case.
For example, many of the contributions that were actually
contributed to pension plans during the early 1980's may not
have been permitted under this assumption and under this
proposal. Plans would therefore be less funded.
The reason for this is that interest rates were very high
during that period of time. The administration's proposal would
actually curtail very sharply the ability of company's to make
contributions during periods of high interest rates.
The plan, if it had been fully funded, based on a very high
interest rate, would have looked very nice to the public, it
would have looked very nice to the plan participants, but in
the end, when the interest rates went down, it would have been
grossly under-funded.
So basing pension plan funding on interest rates alone has
very dangerous consequences.
As a result, we believe that the administration's proposal
would eliminate the plan sponsor's ability to prudently manage
its cash-flow by pre-funding in subsequent years of
contribution when times are good, especially if the interest
rates are high.
Also, being able to manage on a day-to-day basis, a year-
by-year basis, based on when cash-flow is there would be
virtually eliminated by the administration's proposal.
They have asked for and stated that they would increase
their proposal in time.
Mr. Chairman, I'll conclude in a moment, if you just bear
with me for one last statement.
We're concerned about basing funding on pension credit
ratings. In addition to the harm that could do to companies, we
look at the fact that credit rating agencies are not bound by
pension rules.
They may have needs to change what they do ion the future.
They may have to be required to change what they do in the
future.
We believe it's very dangerous to tie the economic health
of millions of Americans to a credit rating system that may
change unilaterally.
We have experience with that, because our current debate
around pension funding originally started because thirty-year
Treasury bills, which pension funding was tied to, were
eliminated.
We believe that we need to step forward and start making
permanent the funding rules adopted last year, the temporary
long-term bond rate, and concurrently, we must focus on the
necessary changes to make the current system work so that we
can deal with both economic times when interest rates are high,
as well as interest rates are low.
Thank you, Mr. Chairman.
I'll entertain your questions.
[The prepared statement of Mr. Porter follows:]
Statement of Kenneth W. Porter, Director of Corporate Insurance and
Global Benefits Financial Planning, The DuPont Company, Wilmington, DE,
on behalf of the American Benefits Council
Chairman Boehner, Mr. Johnson, and Members of the Committee, thank
you for the opportunity to appear before this Committee. My name is
Kenneth W. Porter, Director, Corporate Insurance & Global Benefits
Financial Planning, The DuPont Co. I am serving as a spokesman today,
however, for the American Benefits Council, a public policy
organization representing principally large companies and other
organizations that assist employers of all sizes in providing benefits
to employees. Our members either sponsor directly or provide services
to retirement and health plans covering 100 million Americans. The
American Council of Life Insurers, Business Roundtable, the ERISA
Industry Committee, the National Association of Manufacturers, and the
US Chamber of Commerce also join in the views expressed in this
testimony. We come before you today with a common voice because we all
have a vital interest in encouraging the creation of a regulatory
climate that fosters the voluntary creation and maintenance of defined
benefit pension plans.
Mr. Chairman, we commend you, Mr. Johnson, and the other members of
the Committee for your leadership on defined benefit pension reform.
The six principles that you outlined last September for guiding
congressional efforts to modernize the pension laws provide an
excellent foundation for needed pension reform. These principles should
help to protect the interests of plan participants while ensuring that
any reforms are carefully targeted to specific problems and are not
unnecessarily disruptive.
We agree that reforms are needed to revitalize and support the
defined benefit pension system. It is critical that these reforms focus
on our ultimate goal: retirement security. Because of the reported
deficits at the Pension Benefit Guaranty Corporation (the ``PBGC''),
there is a risk that reform efforts will be focused on the PBGC. While
we wholeheartedly agree that the PBGC must be protected, we should not
lose sight of the fact that the PBGC was set up to strengthen
retirement security through the defined benefit plan system. It would
be tragic and counterproductive if the PBGC is strengthened at the
expense of the pension system as a whole.
A few weeks ago, the Administration released its funding proposals.
The American Benefits Council has also released a set of reform
proposals in a report, Funding Our Future: A Safe and Sound Approach to
Defined Benefit Plan Funding Reform (February 2005), which is attached
to this testimony. That report includes a comprehensive discussion of
the Council's proposals as well as an analysis of the Administration's
ideas.
We commend the Administration for releasing its reform proposals
and there are a number of themes in the Administration's package that
we support. For example, we agree that the funding rules need to be
strengthened. We also agree that more timely disclosure to plan
participants is needed and that measures to allow employers to make
larger contributions during good economic times are long overdue. In
addition, we agree that meaningful safeguards should be considered to
protect the PBGC from benefit enhancements adopted at a time when the
sponsor is unlikely to properly fund those enhancements.
However, we have serious concerns about many of the
Administration's proposals. Our primary concerns are that the proposals
would (1) drastically restrict the predictability of funding and
premium obligations; (2) introduce a counterproductive and troubling
use of credit ratings; (3) create a strong disincentive to pre-fund;
(4) burden the defined benefit plan system with PBGC premium increases
that are not warranted; and (5) fail to stand the test of time. We fear
that the net result would be fewer defined benefit plans, lower
benefits, and far more pressures on troubled companies that jeopardize
the companies' ability to recover.
The remainder of this testimony outlines certain reforms that we
believe should be enacted and describes our analysis of certain aspects
of the Administration's proposals.
Permanent replacement of the 30-year Treasury rate
We strongly recommend permanently replacing the 30-year Treasury
bond rate used for pension calculations with the long-term corporate
bond rate that Congress enacted on a temporary basis last year. Prior
to the Pension Funding Equity Act of 2004, the 30-year Treasury bond
interest rate was required to be used to determine the ``current
liability'' of a defined benefit plan. ``Current liability'' is, in
turn, used in certain circumstances to determine how much a plan
sponsor must contribute in a year to fund a plan. The 30-year Treasury
bond interest rate was also required to be used for various other
pension purposes, including determining the amount, if any, that is
owed to the PBGC as a variable rate premium.
The 30-year Treasury bond rate has become artificially low compared
to other interest rates because of Treasury's buyback program (which
started in the late 1990's) and because of the discontinuance of the
30-year Treasury bond in 2001. The use of this low rate for pension
purposes artificially inflates pension liabilities and funding
obligations. If applicable, these inflated obligations will have
adverse effects on the nation's economy. In addition, concerns
regarding unrealistic funding obligations have already led companies to
freeze plan benefits and many more companies will likely do so if a
permanent replacement for the 30-year Treasury bond rate is not enacted
soon.
Congress recognized that the 30-year Treasury bond rate was a
``broken rate'' last year and enacted a temporary solution, permitting
the use of a long-term investment grade corporate bond rate for 2004
and 2005. That was the right action at the time. Now is the time to
make that change permanent. The long-term corporate bond rate reflects
a conservative estimate of the rate of return a plan can be expected to
earn and is an appropriate discount rate. Businesses need to be able to
make projections about future cash flow demands so that they can make
sound plans for the future. The temporary nature of the rule in effect
today makes planning difficult and can undermine a company's commitment
to the defined benefit plan system.
The Administration has proposed, as an alternative to the long-term
corporate bond rate, a ``yield curve.'' We appreciate that the
Administration's proposal recognizes the need to replace the obsolete
30-year Treasury bond. In particular, we are pleased that the
Administration recommends replacing the 30-year Treasury bond with a
yield curve that uses a conservative, high-quality corporate bond rate.
The proposal, however, differs in two fundamental respects from our
proposal. First, the yield curve interest rate is a ``near-spot rate''
rather than a four-year weighted average rate. This aspect of the
Administration's proposal is discussed in a subsequent section of this
testimony. Second, the yield curve proposal would apply different
interest rates to different payments to be made by the plan based on
the date on which that payment is expected to be made.
The yield curve proposal is troubling in several respects. First,
the proposal would generate numerous different interest rates for each
participant. This level of complexity may, at best, be manageable by
some large companies; it would impose an unjustifiable burden on small
and mid-sized companies across the country. Second, the proposal is
intended to reflect the market and thus be ``accurate''; in fact, the
markets for corporate bonds of many durations are so thin that the
interest rates used would actually need to be ``made up'', i.e.,
extrapolated from the rates used for the other bonds.
Moreover, as we understand the yield curve proposal, it would
reduce the effective discount rate for the typical mature plan below
the long-term corporate bond rate. In many cases, the result would be a
significant increase in liability. For mature plans, the increase could
be more than 10 percent. Using a lower effective discount rate than the
long-term corporate bond rate would result in contributions that would
be materially in excess of those needed to pay benefits. The long-term
corporate bond rate is a very conservative estimate of the rate of
return a plan can expect to earn over the long term and thus is an
economically sound discount rate. Excessive contributions are in no
one's interest, particularly for mature plans in industries that can
least afford to have a sudden required increase in funding obligations.
In addition, plans that are already sufficiently funded to cover all
future benefits using modern econometric modeling (which simulates a
universe of possible outcomes) would appear underfunded under the
Administration's proposal and thus could be required to pay PBGC
variable rate premiums and to make substantial contributions that, in
all probability, will be excessive to the needs of the plan.
Preventing the volatility that ould be created by spot valuations
From business' perspective, perhaps the most important issue
relating to defined benefit plans is predictability. Companies need to
be able to make plans based on cash flow and liability projections.
Volatility in defined benefit plan costs can have dramatic effects on
company projections and thus can be very disruptive. It is critical
that these costs be predictable.
The essential elements facilitating predictability under current
law are:
(1) the use of the four-year weighted average of interest rates
discussed above, and
(2) the ability to smooth out fluctuations in asset values over a
short period of time (subject to clear, longstanding regulatory
limitations on such smoothing).
Some have argued, however, that the measurement of assets and
liabilities should be based on spot valuations and that volatility can
be addressed through smoothing contribution obligations. This approach
is seriously flawed in four respects. First, spot valuations are not
necessarily accurate. For example, the spot interest rates from late
2002 were very poor indicators of interest rates for 2003. It simply is
not logical to conclude that a spot interest rate for one short period
is ``the'' accurate rate for a subsequent 12-month period. Second,
advocates for spot rates have not proposed smoothing mechanisms that
would make contribution or premium obligations predictable. Third,
there has been no recognition of the numerous other rules (e.g.,
deduction limits, benefits restrictions) that do not relate to
contribution obligations and that would become volatile if asset and
liability measurements were based on spot valuations. Fourth, the shape
of the yield curve itself would add to volatility. The yield curve can
change shapes dramatically over very short periods of time. Modeling
shows that pension liabilities for a mature pension plan can vary by
15% or more depending on whether the yield curve is steep, flat, or
inverted. We find it hard to comprehend how the snap-shot shape of the
then-current yield curve can contribute to stable funding of pension
benefits that will be paid out over extended periods of time. For these
reasons, we believe that current-law smoothing rules should be
preserved.
There has been a significant amount of discussion by government
officials and members of the media indicating that defined benefit
plans should be invested in bonds rather than in equities. The bond
proponents argue that this would address business' concerns with
volatility, as well as protect PBGC and plan participants. In the
strongest possible terms, we oppose any legal structure that penalizes
plans for investments in equities. For the reasons discussed below, we
believe that any such structure would be disruptive and harmful to
plans, companies, participants, and the economy as a whole.
If a yield curve or other fundamental change in the pension funding
rules should force a movement of pension funds out of equities and into
bonds or other low-yielding instruments, it would have a marked effect
on the stock market, the capital markets, and capital formation
generally. Hundreds of billions of dollars could move out of the equity
markets with dangerous economic consequences.
Over time, pension plans earn more on investments in equities than
in bonds. If plan earnings decline because plans are compelled to
invest in bonds or other low-yielding instruments, plans' overall costs
will rise. As plans become more expensive, it goes without saying that
there will be fewer plans and lower benefits in the plans that remain.
One primary argument made by the bond proponents is that plan
investment in bonds can be used to ``immunize'' the plan with respect
to its liabilities. The bond proponents contend that employers can
insulate themselves from both volatility and liability by investing in
bonds. First, it is far from clear that there could ever be enough
high-quality bonds available to permit plans to immunize in this
manner. During the ratings process, the credit rating agencies consider
pension plan underfunding and expected near-term pension funding
requirements. Adoption of this proposal would increase reported
underfunded liabilities and, more importantly, materially increase
expected near-term cash flow. It follows, that potentially fewer high-
quality bonds will exist after the proposal is enacted. Thus, if plan
sponsors were to try to immunize their plans by buying bonds, they
would be forced to include lower-quality bonds in their portfolios.
Thus, true immunization may not be possible.
But even if there were enough high-quality bonds to go around, the
immunization arguments do not hold up to scrutiny. Even the staunchest
bond proponents acknowledge that there are numerous pension liabilities
that cannot be immunized. For example, because mortality cannot be
predicted with precision, it is not possible to immunize a plan that
makes life annuity payments. Similarly, the number of people who retire
and take available subsidies can only be estimated and thus that
liability cannot be immunized.
Bond proponents respond to these concerns by maintaining that in a
large pool, mortality and retirement assumptions can be predicted with
reasonable accuracy. This answer is deficient in two crucial respects.
First, it is not applicable to small and mid-sized plans where there is
not a large pool. Second, retirement assumptions are made based on
reasonable predictions. Obviously, these assumptions do not anticipate
unexpected retirement of large numbers of early-retirement eligible
employees. Nor do they recognize emerging economic factors that might
tend to encourage employees to remain employed longer than in the past.
The end result of ``immunization'' is: (1) a lower rate of plan
earnings and correspondingly higher company costs, (2) resulting lower
benefits, and (3) a system that systematically ensures large PBGC
liabilities whenever a plan has unexpected retirements of early-
retirement eligible workers. The higher long-term rate of return
available with equities is what makes plans affordable for companies.
These rates of return also are the most effective means for all
affected parties to weather a downturn in the business of the
sponsoring employer. Investing in equities is critical to the
successful functioning of the defined benefit plan system for
companies, participants, and the PBGC. Thus, it is critical that the
law not establish rules that adversely affect plans investing in
equities.
Rules based on an employer's creditworthiness
We are deeply concerned about the Administration's proposal to base
the application of the pension funding and premium rules on the
creditworthiness of the employer sponsoring the plan. These rules, in
and of themselves, could cause permanent harm to some companies that
would otherwise continue funding their pensions for many years.
Many companies that are not considered ``investment grade'' by the
credit rating agencies, nevertheless continue, year after year, to
generate cash, pay their employees, pay their bills and fund their
pension plans. The mere fact that a company's debt is rated below
investment grade does not mean that it will terminate its plans.
However, the Administration's proposal would classify many plans that
would otherwise never be terminated as ``at risk.'' These
classifications could become a self-fulfilling prophesy as a
precipitous increase in pension funding and premium requirements could
reduce the ability of many companies to continue operating. It is in
everyone's interest for these companies to continue maintaining and
funding their plans.
This proposal would also likely cause investment-grade companies
with lower credit ratings to be downgraded below investment grade. This
would occur because (a) excessive conservatism in the funding rules
would increase the projected near-term cash requirements (an important
factor in determining credit rating), and (b) the credit rating
agencies might be influenced by the additional funding requirements
that would result if the credit rating were downgraded. Impacted
companies would not only be required to dramatically increase their
pension funding, but they would also be required to significantly
increase their cost of debt, if they are able to obtain financing at
all.
In addition, having PBGC premium levels or funding rules turn on an
employer's creditworthiness would also exacerbate the downward spiral
currently experienced by companies that are downgraded. Those pressures
would undermine companies' ability to recover, which adversely affects
all parties, including the PBGC. Finally, there is no practicable way
to apply a creditworthiness test to non-public companies.
Permitting additional contributions in good times
The lesson of the last 10 years is that companies need to be
permitted and encouraged to make additional contributions in ``good
economic times'' so that plans have a funding cushion to rely on during
``bad economic times.'' Trying to squeeze huge contributions from
companies during a downturn in the economy will only lead to freezes on
benefits, company bankruptcies, and large liabilities shifted to the
PBGC. The time to build up pension assets is during good economic
times, not bad times.
The Administration's proposal has the laudable objective of
encouraging funding in better days. However, we are concerned that the
proposal may fall short of achieving this goal, particularly in higher
interest rate environments. For example, many of the contributions
actually made by plan sponsors during the early 1980's might not have
been permissible had this proposal been in effect at that time.
Interest rates during that time were substantially in excess of the
long-term funding assumptions used by plan sponsors under ERISA, which
provided the basis for deductible contributions in those years. If the
Administration's proposal had been in effect, some of those
contributions would not been made and plan sponsors would have had
fewer assets earning the large investment returns that were realized
during the 1980's and 1990s.
Increase in the deduction limit. We strongly support the
Administration's proposal to increase the deduction limits currently in
Code section 404(a)(1)(D) from 100 percent of current liability to 130
percent. In fact, we would recommend increasing the 130 percent figure
to 150 percent to ensure that there is an adequate cushion. For
deduction purposes, current liability is today based on the 30-year
Treasury bond rate, not the long-term corporate bond rate. Under our
proposal, current liability would in the future be based on the long-
term corporate bond rate for all purposes. This would, in isolation,
actually decrease the deduction limit for many plans by 10 percent or
15 percent (and by more for a few plans). Accordingly, to ensure that
the deduction limit for most plans is increased by 30 percent compared
to current law, the limit should be increased to approximately 150
percent.
Repeal of the excise tax on nondeductible contributions. We also
support repealing the excise tax on nondeductible contributions with
respect to defined benefit plans. The excise tax on nondeductible
contributions only discourages employers from desirable advance
funding.
Repeal of the combined plan deduction limit. Finally, we support
repealing the combined plan deduction limit for any employer that
maintains a defined benefit plan insured by the PBGC. Under present
law, if an employer maintains both a defined contribution plan and a
defined benefit plan, there is a deduction limit on the employer's
combined contributions to the two plans. Very generally, that limit is
the greatest of:
(1) 25 percent of the participant's compensation,
(2) the minimum contribution required with respect to the defined
benefit plan, or
(3) the unfunded current liability of the defined benefit plan.
Without repeal of this provision, the sponsor of a plan with large
numbers of retirees might lose its ability to make deductible
contributions to its defined contribution plan. In a mature plan, the
number of active participants is small compared to the number of
retired participants. As a result, 25% of participant compensation
could be less than 5% of the pension plan's liabilities. The
Administration's proposal exacerbates this situation because it
dramatically reduces the discount rate for mature plans. This
simultaneously causes the plan's service cost to increase as a percent
of pay, and the plan's funded status to decline. Even if a mature plan
is 90% funded on this more conservative basis, the resulting minimum
funding requirement could approach or exceed 25% of participant
compensation before considering the deduction for the defined
contribution plan.
This deduction limit can also cause very significant problems for
any employer that would like to make a large contribution to its
defined benefit plan. There is no supportable policy reason for
preventing an employer from soundly funding its plan. Defined benefit
plans and defined contribution plans are each subject to appropriate
deduction limits that are based on the particular nature of each type
of plan. There is no policy rationale for an additional separate limit
on combined contributions.
Eliminating barriers to pre-funding
Under current law, an employer maintaining a defined benefit plan
is generally required to make certain minimum contributions to the
plan. An employer may, however, choose to contribute amounts in excess
of the minimum required. Such ``extra'' contributions give rise to a
``credit balance'', i.e., a type of bookkeeping record of the excess
contributions made by an employer.
Present law is carefully crafted not to discourage ``extra''
contributions. To this end, in years after a credit balance is created,
an employer's minimum funding obligation is determined as if the amount
of any credit balance were not in the plan. Then, the credit balance is
applied against the minimum funding obligation determined in this
manner. In this way, the law is carefully crafted with respect to a
company's decision whether to make extra contributions. The law is
structured to treat a company that makes an extra contribution in one
year and uses the resulting credit balance in a subsequent year in the
same manner as a company that only makes the minimum contribution in
all years.
If credit balances were not available to satisfy future funding
obligations, employers would have a clear economic disincentive to fund
above the minimum levels; funding above the minimum levels would, in
the short term, decrease funding flexibility and increase cumulative
funding burdens. If an employer does not receive credit for extra
contributions, the employer will have an incentive to defer making
contributions until they become required.
The credit balance system has been criticized on the following
grounds: Critics have pointed to examples of underfunded plans that
have not been required to make contributions because of credit
balances. Some of those plans have had their liabilities transferred to
the PBGC. One possible response to this criticism would be to prohibit
the use of credit balances in the case of underfunded plans, as the
Administration has proposed. For employers that previously have made
advance contributions in reliance on the current law rules, any
retroactive changes to the credit balance rules raise fundamental
questions of fairness. On a prospective basis, at first blush, this
type of proposal would seem to increase funding. In fact, the opposite
is true. Such a proposal would lead to more underfunding and more PBGC
liability. If contributions above the minimum amount are discouraged,
few if any companies will make extra contributions. That can only lead
to more underfunding. For example, if the use of credit balances were
restricted, the companies cited by the critics would likely not have
made extra contributions and accordingly, even greater liabilities
would have been shifted to the PBGC and the PBGC would have assumed
these liabilities sooner.
The other criticism of credit balances is that they are not
adjusted for market performance. For example, assume that a company
makes an extra $10 million contribution. Assume further that the plan
experiences a 20 percent loss with respect to the value of its assets
during the following year. Under current law, the $10 million credit
balance grows with the plan's assumed rate of return (e.g., 8 percent)
until it is used. So after a year, the credit balance would be $10.8
million. The critics argue that the credit balance should actually be
$8 million in this example, to reflect the plan's 20 percent loss. This
concern regarding market adjustments is a valid concern that should be
addressed legislatively on a prospective basis and should apply to both
increases and decreases in market value.
As noted above, employers need to be encouraged to make extra
contributions in ``good times'' so that they will have a sufficient
cushion for the ``bad times.'' If the use of credit balances is
restricted, companies would not make extra contributions except in
unusual circumstances. It goes without saying such a restriction that
would be a major step backward. If we want companies to fund more in
good times, it is essential that we preserve the credit balance system.
PBGC Premiums
The PBGC has proposed dramatic increases in premiums in order to
address its deficit. This proposal gives us great concern for several
reasons. First, the proposed increase in the flat dollar premium from
$19 to $30 and its indexing is strikingly inappropriate. This is a
substantial increase on the employers that have maintained a well-
funded plan through a unique confluence of lower interest rates and a
downturn in the equity markets. It is wrong to require these employers
to pay-off the deficit created by underfunded plans that have
transferred liabilities to the PBGC. Many of these plans are well-
funded by any other measure, but under the proposal might be deemed
``underfunded'' and now be required to pay variable rate premiums on
top of this higher base premium. Second, the unspecified increase in
the variable rate premium will become a source of great volatility and
burden for companies struggling to recover. This could well cause
widespread freezing of plans by companies that would otherwise recover
and maintain ongoing plans. This would only be exacerbated by the fact
that the PBGC has proposed an unprecedented delegation of authority to
its Board, rather than Congress, to determine the required premiums.
Third, a premium increase misses the point of the last 10 years. The
solution to underfunding is better funding rules, not higher premiums.
More generally, there has been a striking lack of clarity about the
real nature of the PBGC deficit. The PBGC has reported a $23 billion
deficit as of the end of FY 2004 but there are a number of questions
about the PBGC's situation. First, a substantial portion of the PBGC's
reported deficit represents ``probable'' terminations rather than
actual deficits. Second, the PBGC's numbers are based on a below-market
interest rate and the deficit may be substantially less using a market-
based interest rate. Third, interest rates are at historic lows and
just a few years ago in 2001, the PBGC was operating at a surplus. It
would be useful if we could put the PBGC deficit into context by
understanding the effects of a return of interest rates to historic
norms. Finally, it is not clear why the PBGC has unilaterally moved
away from equities to lower-earning investments that hinder its ability
to reduce its deficit. No one denies that the PBGC faces a serious
situation, and our comprehensive proposals for funding reform are
evidence that the employer community is serious and committed to
shoring up the PBGC's financial condition. However, these are troubling
questions that should be addressed before taking the very harmful step
of increasing PBGC premiums.
Lump sum distributions
The discount rate used to determine the amount of a lump sum
distribution should be conformed to the funding discount rate (which,
as discussed above, should be the long-term corporate bond rate). Under
current law, a rate no higher than the 30-year Treasury rate must be
used to determine the lump sum distributions payable to participants in
defined benefit plans that offer lump sums. As the 30-year Treasury
rate has become artificially low, it has had the corresponding effect
of artificially inflating lump sum distributions (i.e., the lump sum
projected forward using a reasonable rate of return is more valuable
than the annuity on which it was based). This has had very unfortunate
consequences.
First, these artificially large sums are draining plans of their
assets. For example, if a plan determines its funding obligations based
on the long-term corporate bond rate, but pays benefits based on a much
lower rate (such as the 30-year Treasury rate), the plan will be
systematically underfunded. For the defined benefit plans that offer
lump sums (roughly half the plans), the centerpiece of funding reform--
the replacement of the 30-year Treasury bond rate--will simply be
illusory unless the lump sum discount rate is conformed to the funding
rate. Second, participants have clear economic incentives to take lump
sum distributions, instead of annuities. The discount rate should not
artificially create an uneven economic playing field that discourages
annuities.
We recognize that the artificially large lump sums of recent years
have built up employee expectations. For employees near retirement
(e.g., within 10 years of normal retirement age) who have made near-
term plans based on present law, transition relief is clearly
appropriate. But in the strongest terms, we urge policy makers not to
go further than that. If over the next 10 to 15 years, plans are
required to give inflated distributions to retirees, that can only hurt
the defined benefit plan system and future participants. In the
competitive world we live in, pensions are at best a zero sum
arrangement. If employers have to pay inflated benefits for 10 or 15
years, they will have to recoup that cost in some way. It is our fear
that many will feel compelled to reduce benefits for the next
generation, a reduction that will likely carry forward to all future
generations.
We support the Administration's proposal to conform the interest
rate used for determining the amount of a lump sum distribution to the
funding discount rate. However, applying the yield curve to determine
lump sums would (1) appear to further increase the value of lump sums
and thus exacerbate the current law problems described above, (2)
increase benefits for higher paid employees who can afford to let their
benefits remain in the plan longer, and (3) force a significant
reduction in cash balance plan benefits. For these reasons, we oppose
using a yield curve to determine lump sums.
Disclosure
Like the Administration, we strongly support enhanced disclosure of
a plan's funded status. The current-law disclosure tool, the summary
annual report (``SAR''), provides information that is almost two years
old. That is inadequate. We believe that all plans should be required
to disclose to participants year-end data on the plan's funded level
within a shorter time frame.
Year-end data would consist of year-end asset valuation, as well as
beginning-of-the-year current liability figures projected forward to
the end of the year, taking into account any significant events that
occur during the year (such as a benefit increase). Plans should have
the option to use year-end financial accounting standards data in lieu
of the above data. Pension actuaries have struggled during the first
two months of 2005 to comply with the combined effects of (a)
compressed year-end financial disclosure timing imposed on plan
sponsors by the Securities and Exchange Commission and (b) the
implications of Sarbanes-Oxley legislation. Concurrently, the rapid
decline in the number of pension plans over the last 20 years has
moderated the number of new actuaries who embrace the difficult rigors
of pension actuarial work. Because the required disclosure must first
be developed by a limited number of qualified actuaries, there is a
physical limit as to the amount of work that can be completed during
the first six weeks of any year. In our view it is unrealistic to
stipulate yet another set of computational rules and requirements on a
thinly-stretched, yet vital, resource when reasonable alternatives
already exist.
Other proposals would achieve less disclosure, and some of the
other proposals would have serious adverse effects. Some proposals have
been based on the SAR and thus give rise to disclosures that are out-
of-date. Other proposals would require disclosure only from employers
with plans that are more than $50 million unfunded. Those proposals are
inadequate. For example, those proposals would not apply to a plan with
$60 million of liabilities and only $20 million of assets. Moreover,
those proposals inappropriately target large plans. $50 million
represents less than + of 1% of liabilities for large plans (e.g., $10
billion or more of liabilities). Such, a large plan could be 99.5
percent funded but would be subject to disclosure under the proposals
with the accompanying inappropriate stigma of being ``so under-funded''
as to be one of the few plans subject to this additional disclosure.
Certain executive branch agencies have discussed using termination
liability (instead of current liability) for disclosure purposes, which
is significantly higher than current liability. That could mislead and
alarm participants in the vast majority of plans that are not
terminating.
Transition
In certain circumstances, a combination of economic forces--such as
competitive changes within an industry, the aging of a company's
workforce, falling interest rates, and a downturn in the equity
markets--can result in a dramatic change in the viability of a
company's defined benefit plan. In those cases, following the otherwise
applicable rules can only lead to plan termination and severe economic
troubles for the company sponsoring the plan. It is critical that we
develop a different solution for these troubled plans. We recommend
that alternative approaches be developed that would address this
situation in a way that does not increase PBGC exposure, but rather is
structured to reduce that exposure. For example, proposals could be
considered that would generally result in a company in this situation
ceasing benefit accruals (or pay for any new accruals currently) and
funding the shortfall over a longer period of time. Other proposals may
also be discussed.
More generally, as pension funding reform moves forward, transition
issues need to be carefully studied. Large additional funding burdens
that are suddenly imposed can disrupt business plans and cause
otherwise viable companies to become insolvent. Such insolvencies would
only increase burdens on the PBGC. Fairness also dictates that the
rules be phased in slowly for participants, unions, and companies that
have structured their arrangements based on present-law rules.
Hybrid Plans
Mr. Chairman, we appreciate your leadership on the need for a
positive resolution to the uncertain status of hybrid plans, such as
cash balance and pension equity plans. We also strongly support
legislation affirming the legality of hybrid plans designs. Nearly a
third of large employers with defined benefit plans maintain hybrids
and, according to the PBGC, there are more than 1,200 of these plans
providing benefits to more than 7 million Americans, and representing
approximately 20 percent of the PBGC's premium revenue.
Despite the significant value that hybrid plans deliver to
employees, current legal uncertainties threaten their continued
existence. As a result of one court decision, every employer that today
sponsors a hybrid plan finds itself in potential legal jeopardy. It is
critical that this uncertainty be remedied and pension reform
legislation needs to clarify that the cash balance and pension equity
designs satisfy current age discrimination rules.
In addition to clarifying the age appropriateness of the hybrid
plan designs, we believe it is essential to provide legal certainty for
the hybrid plan conversions that have already taken place. These
conversions were pursued in good faith and in reliance on the legal
authorities in place at the time. We also strongly urge you to reject
specific benefit mandates when employers convert to hybrid pension
plans. Employers must be permitted to adapt to changing business
circumstances while continuing to maintain defined benefit plans.
Inflexible mandates will only drive employers from the system and
reduce the competitiveness of American business.
Conclusion
We thank you for the opportunity to present our views. We all agree
that reforms are needed. It is critical, however, that reforms
revitalize and support, rather than undermine, the defined benefit
pension system. In this respect, the Administration's funding proposal
has a number of strengths. However, we are concerned that certain
aspects of the Administration's proposal could harm plans,
participants, companies, and the PBGC itself. We are committed to
working with the Administration and the Congress to ensure that
policies are adopted that will strengthen the PBGC and the defined
benefit pension system.
______
Chairman Boehner. Thank you.
Mr. Stein.
STATEMENT OF NORMAN STEIN, DOUGLAS ARANT PROFESSOR, UNIVERSITY
OF ALABAMA SCHOOL OF LAW, TUSCALOOSA, AL
Mr. Stein. Thank you, Mr. Chairman.
Whether the defined benefit system is in severe or only
moderate financial distress is debatable, but there can be no
honest discussion about that system without acknowledging that
it faces serious challenges.
The administration's proposals to remake the system are
serious and thoughtful. They reflect a particular take on how
much financial risk society should bear with respect to defined
benefit plans.
The administration's answer is, ultimately, not very much
risk, and as such, it would radically reshape the defined
benefit landscape, shifting substantial new financial burdens
and risks on American businesses and their employees.
I want to talk today in my oral remarks about certain
guiding principles that I think should be considered in
discussion of funding rules and Pension Benefit Guaranty
Corporation.
First, the funding rules must be reformed.
The funding rules must move away from allowing plan
sponsors to create large, under-funded, but guaranteed
liabilities, whether at the plan's creation or later through
plan amendment improving benefits, and the funding rules should
not permit plan sponsors to avoid responsible funding by
positing a perpetually optimistic view about future investment
performance or by using actuarial methods that protect plans
from timely recognition of true economic loss.
Second, funding reform is a balancing act, for funding
reform will dampen incentives for firms to sponsor defined
benefit plans.
Funding reforms will reduce the attractiveness of defined
benefit plans to plan sponsors.
They will reduce the plan sponsor's ability to minimize
contribution in times of reduce corporate cash-flow. They will
decrease the ability of plan sponsors to award past service
benefits, to increase benefits in the future, or create early
retirement windows.
They will increase cash-flow volatility unless plan
sponsors invest in debt instruments that match plan
liabilities, which many plan sponsors firmly believe will
substantially increase the long-term costs of plan sponsorship.
Thus, the more fiscal discipline funding rules imposed on
plan sponsors, the fewer the number of businesses that will
choose to sponsor defined benefit plans.
This is simply a reality that should not paralyze, but
should inform congressional consideration of how to improve the
rules.
Third, existing employee expectation, benefit expectation,
should be respected.
Especially in the short term, employee expectations formed
under the current legal regime should be respected.
Thus, for example, broad and immediately effective
restrictions on employees' access to certain types of benefits
where the immediate negation of certain benefit guarantees were
a mandatory freeze on new benefit accruals should be avoided
wherever possible.
Fourth, create fiscally responsible regulatory options that
permit employers and employees flexibility to preserve existing
defined benefit plans.
There are situations in which our current legal regime is
unnecessarily rigid and could be improved by allowing
stakeholders in a pension plan, participants, sponsors, and the
PBGC to negotiate agreements that would increase the
possibility of saving a plan without adding additional
financial burdens to the PBGC.
My written remarks describe a specific idea which in other
presentations I've called a negotiated benefit, benefit
guarantee freeze.
Reserve tax benefits for pension plan assets used for
providing pensions.
The administration's proposals would permit plan sponsors
to contribute and deduct larger plan contributions to plans
than are currently permitted for the purpose of encouraging
better plan funding. This is a laudatory goal, but it has tax
costs.
Thus, such changes should require that pension
contributions are used solely to provide pension benefits to
participants in the plan and cannot be used for unrelated
corporate purposes, and I don't completely agree with Secretary
Combs' remarks that this doesn't happen in today's system.
And finally, as a society, we should accept some
responsibility for the current financial problems in the
defined benefit system.
We should not lose sight of a simple fact. The current
fiscal stresses on defined benefit plans and the PBGC are not
the product of illegal fraud committed by mendacious corporate
managers, nor the selfish actions of the millions of Americans
who relied on these plans.
Rather, the problems are, at least in retrospect, the
results of laws that Congress enacted and of actions that the
executive branch took.
Congress created a statutory scheme in which plan sponsors
were told that they could create benefits and not fully fund
them. Congress created a system in which employers have enjoyed
great flexibility in managing--the administration says
manipulating--annual contribution levels.
As Roy Kinsella told us in ``Field of Dreams,'' if you
build it, they will come. Well, Congress built this structure
and corporate managers came, and did just what we would have
expected rationally economic actors to do: they used the system
to advance what they perceived to be the economic interests of
their firm.
It would be deeply unjust, particularly to the employees
who participate in those plans, to impose immediate, crippling
new funding obligations on plan sponsors to remedy more than a
quarter century of problems that developed under this defective
regulatory scheme.
Such obligations will force the demise of many plans,
bankrupt some employers, and ultimately punish employees who
worked hard and played by the rules.
I would thus suggest as perhaps the most fundamental
guiding principle the idea that we treat the problems with the
statute as two separate problems:
First, what to do about existing liabilities that were
created under the current rules; and second, how employers
should fund new benefits in the future.
As to the latter problem, many of the administration's
ideas are correct: require that new benefit promises be fully
funded when made, that experienced losses be corrected more
quickly than under current law, and that assets and liabilities
be subject to more accurate economic measurement.
As to the former problem, already existing under-funded
liabilities, I would suggest permitting those liabilities to be
amortized over an extended period of time, but to address some
of the more glaring flaws in the intersection of Title 4 of
ERISA and the bankruptcy laws that hamper the PBGC's mission.
In other words, get funding rules right for benefit
liabilities created tomorrow and forever thereafter, but be
lenient with liabilities already created. To paraphrase
Condaleeza Rice, an Alabama native, forgive yesterday's errors
but punish tomorrow's sins.
[The prepared statement of Mr. Stein follows:]
Statement of Norman P. Stein, Douglas Arant Professor, University of
Alabama School of Law, Tuscaloosa, AL
Mr. Chairman, Members of the Subcommittee, I am Norman Stein, a
professor at the University of Alabama School of Law, where I am
privileged to hold the Douglas Arant Professorship. I teach and write
in the area of tax, labor and employee benefits. I thank you for the
privilege of being able to share my views with you. My comments are my
own and do not reflect the views of the University of Alabama, which I
can, however, assure you has no views of its own on this subject.
Whether the defined benefit system is in severe or only moderate
financial distress is debatable, but there can be no honest discussion
about that system without acknowledging that it faces serious
challenges. The Administration's proposals to remake the system are
serious and thoughtful. They reflect a particular take on how much
systemic financial risk plan participants, plan sponsors, and,
ultimately, society should be asked to bear with respect to defined
benefit plans. The Administration's answer is ultimately not very much
risk and, as such, it would radically reshape the defined benefit
landscape.
As my remarks will suggest, I do not fully agree with the
Administration's answer--as reflected in its proposals--but in saying
this, I should make two important preliminary observations: first, that
there is no single right answer to this basic question of how much risk
is acceptable; and second, that the system currently tolerates too much
risk. It is ultimately for this Congress to determine how much risk is
optimal. Congress's determination, however, will have profound
implications for the future retirement income security of the millions
of employees and retirees now participating in that system, the
economic viability of the firms that sponsor them, and the long-term
sustainability of the traditional defined benefit plan, which is the
crown jewel of our private sector retirement system.
My written remarks are divided into two parts: first, I will argue
for some guiding principles for addressing the problems facing the
defined benefit system: these principles reflect my own views about how
much risk we should be willing to tolerate to support the defined
benefit system; second, I will offer some specific ideas that should,
in my view, be part of the discussion, including some concerns with
specific aspects of the Administration's proposals.
I. Guiding Principles
1. Funding Rules Must Be Reformed. Today's statutory regime invites
inadequate funding of defined benefit plans and imposes too much risk
on participants and society generally. The funding rules must move away
from allowing plan sponsors to create large unfunded but guaranteed
liabilities, whether at the plan's creation or later through plan
amendment improving benefits. And the funding rules should not permit
plan sponsors to avoid responsible funding by positing a perpetually
optimistic view about future investment performance or by using
actuarial methods that protect plans from timely recognition of
investment and other experience losses.
2. Funding Reform Is a Balancing Act, for Funding Reform Will
Dampen Incentives for Firms to Sponsor Defined Benefit Plans. Funding
reforms will reduce the attractiveness of defined benefit plans to plan
sponsors. They will reduce a plan sponsor's ability to minimize
contributions in times of reduced cash flow. They will decrease the
ability of plan sponsors to award past-service benefits, to increase
benefits in the future or create early retirement windows. They will
increase cash-flow volatility unless plan sponsors invest in debt
instruments that match plan liabilities, which many plan sponsors argue
would increase the long-term costs of plan sponsorship. Thus, the more
fiscal discipline funding rules impose on plan sponsors, the fewer the
number of businesses that will choose to continue to sponsor, or to
adopt new, defined benefit plans. This is simply a reality, but a
reality that should not paralyze Congressional will to improve the
funding rules.
Ultimately, we will have to move to a world in which there are
better funded, even if perhaps fewer, defined benefit plans. But with
every measure Congress considers, it should ask whether the gain in
fiscal discipline is sufficiently meaningful to dilute willingness to
sponsor defined benefit plans. Where possible, we should want to
encourage employers to continue to sponsor, and to adopt new, defined
benefit plans. Thus, devising appropriate funding reforms requires a
thoughtful balance of competing interests. We should certainly adopt no
measure that reduces employer willingness to sponsor defined benefit
plans unless the measure would produce demonstrable rather than
theoretical gains in the financial security of plan benefits.
3. Existing Employee Expectations Benefit Expectations Should Be
Respected. Especially in the short term, employee expectations formed
under the current legal regime should be respected wherever possible.
Thus, for example, broad and immediately effective restrictions on
employee's access to certain types of benefits, or the immediate
negation of certain benefit guarantees, or a mandatory freeze on new
benefit accruals, should be avoided wherever possible.
4. Create Fiscally Responsible Regulatory Options That Permit
Employers and Employees Flexibility To Preserve Existing Defined
Benefit Plans. There are situations in which our current legal regime
is unnecessarily rigid and could be improved by allowing stakeholders
in a pension plan--participants, sponsors, and the PBGC--to negotiate
agreements that would increase the possibility of saving a plan without
adding additional financial burdens to the PBGC. This might, for
example, be accomplished by shifting some additional future risk from
the PBGC to employees and shareholders instead of terminating a plan or
imposing crushing immediate cash demands on the plan's sponsor. (I will
discuss a specific idea--a negotiated guarantee freeze--in the next
section.)
5. In Shaping Funding Reforms, Congress Should Reserve Tax Benefits
for Regulatory Rules that Ensure that Pension Plan Assets are Used for
Providing Pensions. Some changes favored by the Administration and
private interest groups would permit plan sponsors to contribute and
deduct larger plan contributions to plans than are currently permitted,
for the purpose of encouraging better plan funding. This is a
worthwhile goal, but it has tax costs. Thus, such changes should
require that pension contributions are used to provide pension benefits
to participants in the plan and cannot be used for unrelated corporate
purposes.
6. As a Society, We Should Accept Some of the Responsibility for
the Current Financial Problems in the Defined Benefit System. We should
not lose sight of a simple fact: the current fiscal stresses on defined
benefit plans and the PBGC are not the product of illegal fraud
committed by mendacious corporate managers nor the selfish actions of
the millions of Americans who have relied on defined benefit plans.
Rather, the problems are, at least in retrospect, the results of the
laws that Congress enacted and of actions taken by the Executive
branch.
Congress created a statutory scheme in which plan sponsors were
told that they could create benefits and not fully fund them for 30
years, even though PBGC guarantees were phased in over 5 years.
Congress created a scheme in which plant shutdown benefits were insured
even though they were rarely funded. Congress created a system in which
employers have enjoyed great flexibility in managing--some might say
manipulating--annual contribution levels and were protected from sudden
and unpredictable changes in funding obligations through various
actuarial smoothing methodologies.
As Roy Kinsella told us in Shoeless Joe, if you build it, they will
come. Well Congress build this structure and corporate managers came
and did just what we would have expected rationally economic actors to
do: they used the system to advance the economic interests of the firm,
its shareholders and employees. It would be unfair--particularly to the
employees who participate in those plans--to impose immediate crippling
new funding obligations on plan sponsors to remedy more than a quarter
century of problems that developed under this defective regulatory
scheme. Such obligations will force the demise of many plans, may
bankrupt some employers, and ultimately will punish employees--who
worked hard and played by the rules--with benefit and job losses.
Moreover, the worst of the problems of defined benefit plans are
concentrated in a few industries that have undergone major structural
change, partly in response to actions taken by the Federal government.
The airline industry is a case in point. The pension promises that the
traditional airline carriers made to their employees were reasonable
when the pension plans were established. These carriers are, in my
view, to be commended for trying to meet those promises to their
employees, even after Congress ushered in deregulation and allowed
discount airlines to compete on lower labor costs, benefiting the
public but harming the traditional carriers and their employees. If the
airline industry had not been deregulated, United, Delta, and U.S.
Airways would have been better situated to fund their pension plans
adequately. A similar story can, of course, be told about how changes
in global trade has harmed the steel industry.
I would thus suggest as perhaps the most fundamental guiding
principle the idea that we treat the problems with the statute as two
separate problems: first, what to do about existing liabilities that
were created under the current funding rules; and second, how employers
should fund new benefits in the future. As to the latter problem, I
think many of the administration's ideas are correct: require that new
benefit promises be fully funded when made, that experience losses be
corrected more much quickly than under current law, and that assets and
liabilities are subject to more accurate economic measurement.
As to the former problem--already existing unfunded liabilities--I
would suggest permitting those liabilities to be amortized over an
extended period of time, but to address some of the glaring flaws in
the intersection of Title IV of ERISA and the bankruptcy laws that
hamper the PBGC's mission.
In other words, get funding rules right for benefit liabilities
created tomorrow and forever thereafter, but be lenient with
liabilities already created. Forgive yesterday's errors but punish
tomorrow's.
II. Specific Ideas
I offer the following specific ideas:
Funding of Plans and Limitations on Benefits
1. The Corporate Bond Rate Understates True Pension Liabilities.
The Department of Treasury has suggested that the interest rate for
discounting plan liabilities be changed permanently from the 30-year
treasury rate to long-term corporate bond rates. The result of this
change is less rather than more plan funding, an odd position for the
Department of Treasury to take. In addition, the corporate bond rate
lacks adequate conceptual justification: such rates are higher than the
discount rate that would be used by an insurance company in valuing a
plan's liabilities and the corporate bond market is thin, particularly
with respect to bonds with long durations. Moreover, corporate bond
rates are subject to risk, although Title IV purports to make payment
of benefits riskless to participants up to PBGC guarantee levels. The
appropriate discount rate should therefore be pegged to riskless, or
nearly riskless, instruments, such as government-issued bonds.
2. The Yield Curve. The Administration has proposed that plan
liabilities be discounted to present value using a yield curve derived
from interest rates on high-quality corporate obligations. For some
plans, such a yield curve may actually reduce funding obligations,
which we think is counter-productive to the Administration's purported
goal of improving plan funding; for other plans--those with a mature
workforce and many retirees, a yield curve would substantially increase
funding and perhaps force bankruptcies and create job loss in important
sectors of our economy.
These economic consequences to firms and their employees should not
be ignored in the funding debate. And I would also argue that changes
to the funding rules that will add new financial stresses to challenged
sectors of the economy must not be made in a funding vacuum: some
changes--for example, mortality tables tailored to reflect the shorter
life expectancies of employees in some industries and in some mature
plans--should be considered as part of the same funding debate, of
which the proper discount rate is but one part.
Also, if a yield curve is to be used, it might be advisable to
exempt smaller plans, for whom the increased accuracy in liability
measurement might not justify the complexity and expense of compliance.
3. Adjusting the Full-Funding Limitation. The Administration
proposal would increase the full funding limitation, permitting plan
sponsors to make larger contributions in ``good'' years, which would
then reduce contribution obligations in less profitable or loss years.
I am skeptical that this would do much to improve the funding of at-
risk plans, since increased contributions would primarily be made by
the strongest firms, which would have an interest in using the plan's
tax-exempt status to favorably fund future payroll costs. Nevertheless,
the only harm to increasing maximum contribution obligations is loss of
potential tax revenue--tax revenue that might be better spent to shore
up the PBGC directly.
In any event, if profitable firms are going to be able to enjoy the
substantial tax advantages of aggressively overfunding their pension
plans, it is important that the funding be irrevocably committed to
providing pension benefits for the participants in the pension plan.
Despite the reversion tax, employers have found numerous ways of using
the surplus in an ongoing plan for general corporate purposes. (Some of
these practices were documented in a 2003 story in the Wall Street
Journal.) When a plan is overfunded, the assets in excess of the
present value of plan liabilities should be regarded as a rainy-day
fund for harder economic times, which the business cycles of a market-
driven economy ensure will recur. Thus, an increase in the contribution
limits should include new restrictions on how excess plan assets can be
used.
4. The Role of Firm Creditworthiness. The Administration's proposal
would calculate plan liabilities differently for firms with debt
ratings below investment grade. The effects of this calculation would
include increased plan contributions and limits on a participant's
right to a lump sum distribution.
There are some important issues that should be addressed in the
Administration's proposals, the most fundamental of which is whether
the government should be using credit scores from unregulated and
sometimes conflicted ratings agencies to help measure contribution
obligations or to restrict participant access to certain benefit forms.
But the Administration's proposals, as they stand, have some details
that need to be thought through. For example, a firm with a below-
investment grade rating would for funding purposes assume a greater
incidence of lump sum payouts, even though other parts of the
Administration's proposal might limit the availability of such payouts
to participants in such plans. And the Administration's proposals treat
employees whose debt was just recently reduced below investment grade
more leniently than companies who have had such a rating for a longer
period of time. If a company is rated as a serious credit risk, it is a
serious risk no matter how long it has had such status. The proposal
does not explain why different treatment is appropriate, except as a
phase-in.
More fundamentally, if a firm's creditworthiness is a valid
consideration under ERISA (and I lean toward the view that it is), a
perhaps better use for credit ratings would be to reward high levels of
creditworthiness rather than merely penalize low levels: I would
consider allowing firms with high credit ratings to use actuarial
smoothing methods and more flexibility with respect to actuarial
assumptions, if they choose, to reduce volatility in contribution
obligations.
5. Freeze on Benefit Accruals. The Administration proposal would
require that certain underfunded plans freeze future benefit accruals
and would bar benefit improvements. Such restrictions are wrong, so
long as new benefits are fully funded and old benefit liabilities are
being amortized under appropriately rigorous schedules.
6. Restrictions on Lump Sums. Many participants have relied upon
the availability of lump sum payments. The Administration's proposal is
correct that such payments can drain plan assets and can allow some
employees to take benefits that will, ultimately, prove to be larger
than the PBGC guaranteed benefits that the participant would have
received had the plan terminated. An intermediate position, which
better recognizes the expectations of employees, would be to permit
payment of partial lump sums with a reduced annuity benefit. Moreover,
if an underfunded plan is brought up to adequate funding, employees who
were forced to take an annuity should be permitted--with perhaps
certain limitations--to take a lump sum benefit equal to the present
value of remaining annuity payments.
7. Changes in Interest Rates for Lump Sum Benefits. Many pension
plans provide participants with the opportunity to elect to receive
their benefits as single sum amounts, and most pension plans actually
force participants to take lump sums if the value of their benefit is
less than $5,000. In determining the value of the benefit, and hence
single-sum amount the participant will receive, the Internal Revenue
Code requires that the plan use an interest factor equal to interest on
a 30-year treasury bond. Some trade groups and employers, and the
Administration, argue that plan solvency would be helped if the
discount rate were changed to corporate bond rates, which would have
the effect of substantially reducing the value of such single-sum
payments.
While I am not an advocate of lump sum distribution options, it
also seems plain to me that once a firm promises an employee a benefit,
it should not be able to break that promise. Employees view pension
plans as contracts and the interest rate used for valuing lump sums is
a part of those contracts. Those who would change the interest rates
are, in effect, asking Congress to relieve them of a bargain they made
with their workers.
Some who argue for reducing lump sum benefits argue that it is
unfair that employees are choosing lump sums because they are
economically more valuable than annuity benefits. But since when in our
economic system is it wrong for people to choose the most advantageous
contractual option available to them? Moreover, when an employee elects
a lump sum benefit, the employee loses the insurance protection
provided by the PBGC, which itself has economic value. And we doubt
that most working people will be able to realize a rate of return equal
to the interest rate on corporate bonds, at least without exposing
themselves to substantial market risk. In addition, the plan saves
substantial administrative costs when it cashes out small benefits that
often exceed the actual present value of the benefits to the employee.
Finally, in some cases, employees choose lump sums not as a wealth
maximizing strategy, but simply because they do not trust their former
employer with their money. Indeed, in many cases where a plan offers a
subsidized early retirement benefit, the lump sum--even with its value
being determined with a discount rate equal to the interest rate on a
30-year treasury obligation--can exclude the subsidy and thus be worth
substantially less than the annuity benefit. Yet many workers
nevertheless select the less valuable lump sum.
Whatever the merit of the argument for allowing employers to break
their contractual obligations to people who have a choice of whether to
take a lump sum or annuity benefit, there is no reasonable argument
that we should reduce lump sums for workers when their employers
``force'' them to take lump sums. Such workers, because of the small
amounts they receive (less than $5,000), will have limited investment
opportunities and will not be able to achieve a rate of return equal to
the corporate bond rate. In addition, empirical research shows that the
larger the lump sum, the more likely it is that an employee will save
some of it for retirement by rolling it over into an IRA. Reducing the
amount of the lump sum for these employees will thus contribute to
asset leakage from the retirement system. Finally, increasing the
interest rate will increase the number of employees who will be forced
to take a lump sum, for a larger number of annuity benefits would have
a present value of less than $5,000.
Plan Terminations and Title IV of ERISA
8. Variable Premium Increases . The Administration's proposal
contemplates substantial increases in the variable premium paid by
seriously underfunded plans. This will put more financial stress on
already stressed firms, making it harder for them to shore up the
funding of their own plans. A better approach would be for a portion of
the variable premium to be paid to the plan, in addition to its
ordinary contribution, Such payments could be segregated in a separate
fund and if the plan ultimately terminates, the fund could be allocated
entirely to guaranteed benefits.
9. Use of General Revenues. There might be periodic or episodic
appropriations to the PBGC from general revenues (which might be paid
for by a partial rollback of the recent increases in IRC Section 415
and elective contribution limits, which have reduced taxes for the
wealthiest individuals while doing little to improve retirement
security for average American workers). Such appropriations are, I
believe, justifiable, since as I have already observed, Congress and
the Federal government bear some responsibility for the funding
challenges the system now faces.
Moreover, the PBGC serves not only an insurance function, but also
a social insurance function. Currently, firms with low-risk defined
benefit plans fund the social-insurance mission of the PBGC by paying
premiums that are larger than needed to cover the actual risk of their
plans terminating with insufficient assets. In effect, this is a tax on
such firms. It might be fairer to shift part of this burden to a wider
universe of taxpayers.
10. Impose an Exit Charge on Employers Who Leave the Defined
Benefit System. To prevent flight of healthy firms from the defined
benefit system, an exit charge (or withdrawal liability) might be
imposed on employers who voluntarily terminate their defined benefit
plans. When they leave the system, they saddle a larger portion of the
PBGC's unfunded liabilities on the employers who remain behind; in
effect, the system currently rewards those who desert the system by
relieving them of future premium responsibility.
11. Impose a Small PBGC Charge on Sponsors of Defined Contribution
Plans. As I just noted, a portion of the cost of subsidizing failing
defined benefit plans is born by sponsors of healthy defined benefit
plans. Congress might consider imposing on sponsors of defined
contribution plans (who do not also sponsor defined benefit plans) a
small charge so that this cost is shared by sponsors of all tax-
subsidized plans.
12. Plant Shutdown Benefits. The Administration proposal would
immediately cancel PBGC guarantees for plant shutdown benefits and
beginning in 2006 would prohibit pension plans from offering such
benefits. Both of these ideas are ill-advised.
Plant shutdown benefits are critical benefits for employees at a
time when they are subject to particularly harsh economic dislocations.
Those benefits are currently insured and to suddenly end those
guarantees without a transition period would be to break faith with
some of the nation's most vulnerable workers.
An alternative to prohibiting a pension plan from offering plant
shutdown benefits might be to create a separate insurance program for
such benefits, with a risk-based premium. This idea should at least be
explored.
13. Negotiated Benefit Guarantee Freezes. Under current law, there
are two options open to an employer contemplating a voluntary
termination or to the PBGC contemplating an involuntary termination: go
ahead and terminate the plan or continue the plan (with or without a
benefit freeze). If the plan is terminated, the employees lose not only
future benefit accruals, but also the amount by which their benefits
exceed the PBGC guaranteed benefits. But if the plan does not
terminate, the employer's funding obligations continue unabated at a
time when such contributions might force the employer out of business
and the PBGC's potential liabilities continue to grow. It should be
possible for the plan sponsor, the employees (through either their
collective bargaining representative or an elected committee if the
employees are not represented), and the PBGC to negotiate alternatives
to the two stark and often unsatisfactory choices now available.
Under a negotiated agreement, the PBGC would be protected from
additional liabilities by freezing benefit guarantees and Title IV
asset allocations as of the date of the agreement. The agreement might
allow the employer to temporarily reduce its funding obligations and
might allow the continuation of benefit accruals, so long as employees
understood that new benefits would not be guaranteed unless the plan is
ultimately fully funded.. Such agreements, which could be tailored to
particular situations and should be limited in duration, would harm no
stakeholder and would offer potential benefit to all stakeholders. It
is an idea that merits discussion, especially for situations where the
employer is undergoing reorganization proceedings.
Thank you. I would be happy to take any questions.
______
Chairman Boehner. Thank you, Mr. Stein.
Dr. Mulvey.
STATEMENT OF JANEMARIE MULVEY, CHIEF ECONOMIST, EMPLOYMENT
POLICY FOUNDATION, WASHINGTON, DC
Ms. Mulvey. Good morning, Chairman Boehner, Ranking Member
Miller, and Members of the Committee. Thank you for the
opportunity to appear before you today.
This hearing comes at a crucial time, and I would like to
commend the Bush Administration for introducing a pension
reform proposal for Congress to consider.
The majority of large employers have been voluntarily
providing pension coverage for many years, and they recognize
the importance of this coverage to the retirement security of
their workers, yet plan sponsors face increased pressure from
regulatory, economic, and demographic forces.
Since the mid-1980's inflation-adjusted administrative
costs have more than doubled. More recently, declining equity
and interest rates have eroded their pension assets.
And finally, attempts by firms to establish hybrid pension
plans to meet the needs of a more mobile workforce have faced
legal challenges.
The combination of these forces have prompted many plan
sponsors to reevaluate the cost effectiveness of continuing to
offer a defined benefit plan.
The two stated goals of the administration proposal are to
protect workers and to avoid a taxpayer bailout.
A third goal should also be considered. That is, pension
reforms should be evaluated relative to their ultimate cost
impact for healthy plan sponsors. Any reform should not
compromise their ability to afford these plans in the future.
Having said this, there are both positive and negative
aspects of the administration proposal.
On the positive side, the administration proposes to
increase the current funding limit, would allow firms to
increase funding during good times and provide a buffer for
recessionary periods.
The administration proposal would also consolidate the
accounting and actuarial measures, thereby reducing some of the
administrative burden on plan sponsors. However, the ultimate
measure agreed upon must carefully consider its impact on plan
sponsors and overall plan funding.
For example, the administration proposes the use of a spot
rate for determining pension liabilities to replace the current
practice of a 4-year weighted average. The use of a spot rate
could increase the volatility of pension liabilities,
especially during steep economic cycles.
Further, the administration proposes the use of a more
complex yield curve to estimate pension liabilities. Those
industries with an older than average workforce would be most
adversely affected by the use of a yield curve, specifically
the manufacturing, transportation, utilities, and
communications sectors.
These costs will further be exacerbated by the proposed
increase in PBGC premiums. While premium increases appear
inherently small, they will also be borne predominantly by the
manufacturing industry, an industry that is still recovering
from the earlier economic downturn.
The release of the administration's proposal underscores
the high level of interest in the Bush Administration to
preserve the DB pension system for workers and improve its
future solvency, which is commendable. However, in doing so,
policymakers should consider whether the reforms being
considered would lead to increased pension costs of healthy
companies and whether those increased costs would seriously
compromise ability to afford the plans.
In addition, policymakers should give careful consideration
to whether the reforms unduly restrict hybrid plan conversions,
or impose strict mandates such as requiring choice or
grandfathering for all current workers.
Both the administration and Congress must recognize that
employer-provided retirement benefits are voluntary. If pension
reforms were to impose additional and unnecessary costs on
already healthy plans, policymakers should ask whether these
changes would ultimately force many to exit the system
altogether and substitute a defined contribution plan.
Ironically, if that were to occur, as more firms exited the
system amidst rising costs, the available pool for PBGC
premiums would eventually decline. Obviously, such an outcome
would defeat the intent of the administration's proposal, which
was to help preserve the DB pension system in the first place.
Thank you for the opportunity to present my views, and I
would be glad to answer any questions.
[The prepared statement of Ms. Mulvey follows:]
Statement of Janemarie Mulvey, Ph.D., Chief Economist, Employment
Policy Foundation, Washington, DC
Chairman Boehner, Ranking Member Miller and members of the
committee, thank you for the opportunity to appear before you today. My
name is Janemarie Mulvey, and I serve as Chief Economist of the
Employment Policy Foundation (EPF). EPF is a research and educational
foundation founded in 1983 that focuses on workforce trends and
policies. This hearing on pension reform comes at a crucial time.
Currently, the defined benefit pension system continues to face
increased pressure from regulatory, economic and demographic forces.
Since the mid-1980s, increased regulatory and compliance requirements
have more than doubled the administrative costs of plan sponsors.\1\
More recently, declining equities and interest rates have reduced the
asset values of corporate pensions, forcing many plan sponsors to
increase their funding contributions during the recent economic
recession. At the same time, bankruptcies in the steel and airline
industries have left the major insurer of private pensions--the Pension
Benefit Guarantee Corporation (PBGC)--with a $23 billion deficit.
Finally, attempts by firms to redesign their traditional defined
benefits plans to meet the needs of a more mobile workforce have faced
legal challenges. Given these pressures, plan sponsors are re-
evaluating the cost-effectiveness of offering a defined benefit (DB)
plan to their employees.
---------------------------------------------------------------------------
\1\ Hustead, Edwin C. 1998 ``Trends in Plan Administration,'' in
Living With Defined Contribution Pensions ed. Olivia Mitchell and
Sylvester J. Schieber, The Pension Research Council Wharton School,
University of Pennsylvania.
---------------------------------------------------------------------------
We commend the Bush Administration for putting forth a pension
reform proposal to begin to address some of these issues. As you know,
the Administration proposal addresses three key areas:
<bullet> Reforming funding rules;
<bullet> Reforming insurance premiums; and
<bullet> Improving disclosure.
While the Administration proposal represents an important step
toward reforming our nation's pension system, there are some areas of
which the proposal warrants serious discussion. My testimony will
highlight those key areas and their potential implications for plan
sponsors.
Reform Funding Rules
The Administration proposes changes to the pension funding rules in
three key areas:
<bullet> Consolidate the accounting and actuarial measures;
<bullet> Tie pension valuations to a yield curve; and
<bullet> Increase the funding limit.
Consolidate the Accounting and Actuarial Measures
The actuarial calculation of pension liabilities for funding
purposes is no doubt complicated and depends on a number of assumptions
about interest rates, mortality, and other factors. Furthermore, these
actuarial estimates are not consistent with those reported on a firm's
financial disclosure form. The Administration proposes to make the
actuarial and accounting rules more consistent. On the plus side,
moving to one consistent measure of pension liabilities could reduce
the administrative complexity and avoid computing two distinct
measures--one for accounting purposes and one for funding purposes.
However, beyond the administrative savings that might occur, the
ultimate impact on plan sponsor's balance sheets will depend on the
details of the eventual formula and assumptions that evolve from the
upcoming debate.
Tie Pension Valuations to a Yield Curve
The Administration has proposed some major changes in the interest
rate used when employers value their pension plans. This change may
adversely affect plan sponsor's reported pension liabilities.
Currently, plan sponsors rely on a four-year weighted average of a
long-term bond rate. The Administration proposes that plan sponsors use
a ``spot'' rate rather than a four-year weighted average. While
interest rates have been less volatile in recent years, these rates
diverged considerably in the late 1980's (see Figure 1). Thus, the use
of a spot rate could increase the volatility of pension liabilities
during certain periods and raise required contributions above a level
that might not be necessary when viewed over the longer-time period.
This volatility also would make it more challenging for firms to
develop reliable long-term financial and/or strategic plans for their
company.
[GRAPHIC] [TIFF OMITTED] T9772.008
The Administration also proposes that firms use a more complex
yield curve to better align pension liabilities with their expected
duration. Under the proposal, firms must discount future pension
liabilities using a short-term interest rate for older workers near
retirement and a long-term interest rate for younger workers who are
still many years from retirement. By tying these liabilities to a yield
curve, an EPF analysis shows that under the current interest rate
environment, plan sponsors could experience a 3.5 percent increase in
calculated pension liabilities for workers ages 55 and older and a 2.0
percent increase for workers ages 50 to 54. This could
disproportionately affect firms that have a higher share of older
workers. Specifically, the manufacturing, transportation, utilities and
communications industry could be hardest hit by the proposed change.
Increase the Funding Limit
The Administration also proposes raising the current limit on the
amount a firm can fund on a tax-qualified basis. This limit has
prohibited plan sponsors from making additional tax-qualified
contributions when profits were rising. Thus, during the recent
recession, when their asset values were falling, firms had to increase
their contribution rates at a time when they were less likely able to
afford to do so. The Administration proposal would allow firms to fund
up to 130 percent of this limit and would index future increases to
growth in wages rather than consumer prices. This would positively
impact firm's ability to pre-fund their pension liabilities, especially
during upturns in the business cycle.
Reform Insurance Premiums
The Employer Retirement Income Security Act established the PBGC in
1974 to insure the private-sector DB pension participants against
default. Over the past few years, the financial viability of the
program has come into question prompted by some well-publicized
bankruptcies. According to the PBGC, since 1975, the firms representing
the ten largest claims have accounted for more than sixty percent of
all claims against the PGBC.\2\ These claims have been concentrated in
two major industry groups--steel and airlines. Furthermore, over the
past few years, claims paid for two major firms--one steel and one
airline--have reached historical highs. In 2003, the PBGC took over
$3.7 billion in claims for unfunded pension liabilities from a large
steel company. At the time, this was the highest claim ever paid by the
PBGC. More recently, claims by a major airline are expected to surpass
this earlier claim, and are expected to top $7.5 billion. As a result
of the bankruptcies of only a few companies, the PBGC reported a
deficit of $23 billion in 2004. To close the PBGC's budget shortfall,
the Administration proposes to raise the fixed rate premium from $19 to
$30 per participant and to tie future premium increases to wage growth.
Their rationale for this proposed increase is that PBGC premiums have
not risen since 1991. While $11 per participant appears like a small
increase in absolute terms, in percentage terms it represents a 58%
increase. For very large firms, these dollars can certainly add up
quickly.
---------------------------------------------------------------------------
\2\ Pension Benefit Guaranty Corporation, Pension Insurance Data
Book, 2003.
---------------------------------------------------------------------------
More importantly, since the majority of pension plan participants
are in the manufacturing sector, an EPF analysis estimates that
manufacturers, which comprise over 16 million pension plan
participants, will pay $178 million more in premiums under the
Administration proposal. This represents 49% of all proposed premium
increases (see Figure 2). These costs will be further compounded for
manufacturers with an older than average workforce who would be funding
their plans at higher rates if pension liabilities are tied to the
yield curve, as discussed above. These additional costs would be
imposed on an industry that is still trying to rebound from declining
profitability in some key sectors like computers, electronic products
and motor vehicles.\3\
---------------------------------------------------------------------------
\3\ U.S. Department of Commerce, Bureau of Economic Analysis,
National Income and Product Accounts, Table 6.16D.
[GRAPHIC] [TIFF OMITTED] T9772.009
Change the Structure of Variable Rate Premiums
In addition to raising the fixed rate premiums, the Administration
proposes to change the structure of variable rate premiums to better
reflect the default risk of under- funded plans. Currently, employers
with under-funded plans pay an additional premium of $9 per participant
for each $1,000 that their plan is under-funded. Under the
Administration's proposal a risk-based premium will be charged to each
plan that is under-funded relative to its funding target based on the
percentage of the shortfall. Furthermore, firms in the at-risk category
will not be allowed to raise the generosity of their benefits,
preventing them from over-promising benefits that they may not be able
to pay in the future. The specific details of the calculation of the
risk-based premium are not yet available. From a fairness perspective,
the proposal does try to increase the premium burden for at-risk plans
versus those not at-risk. However, it will be important that the
definition of at-risk is clearly defined and represents an accurate
depiction of a firm's financial state. To do this, reform measures
should take into account the possibility of short-term volatility in a
plan sponsor's financial situation.
Improve Disclosure
The Administration also proposes to improve both the content and
timeliness of the disclosure of pension liabilities. For workers and
retirees, this information will provide them a better measure of the
security of pensions in the future. For regulators, these efforts will
allow them to improve their evaluation of plan sponsors' financial
obligations and potential risk of default in the future. Specifically,
the Administration proposes to:
<bullet> Improve disclosure of plan funding status and funding
trends;
<bullet> Make publicly available certain information filed with
the PBGC by under-funded plans; and
<bullet> Provide for more timely reporting and limits on filing
extensions of plan annual reports.
Again, the details of the timing of increased disclosures and other
facets of this part of the proposal have not been developed, so it is
difficult to evaluate the implications on plan sponsors at this point
in time. But generally, as noted earlier, any changes proposed should
attempt to reduce--rather than increase--the administrative burden of
plan sponsors.
Hybrid Pension Plans
In releasing their pension reform proposal, the Administration also
said it would soon support a hybrid plan proposal, which could resolve
some of the legal challenges surrounding the cash balance debate.
However, their current hybrid proposal still includes a five-year hold
harmless provision that would certainly discourage plan sponsors from
transitioning to a hybrid plan. It is important that any reforms
recognize that most plan sponsors have implemented hybrid plans to meet
the needs of a more mobile workforce and not necessarily to reduce
their pension expenses. Today's workers seek more portable yet
guaranteed benefits, which hybrid plans provide.
Conclusion
The release of this proposal underscores the high level of interest
the Bush Administration has in preserving the DB pension system and
improving its future solvency, but many of the proposal's implications
for plan sponsors will not be evident until the actual details are
worked out in Congress and in the regulatory process. In the end,
pension reforms should not lead to increased pension costs of
``healthy'' companies that would seriously compromise their ability to
afford these plans in the future; nor should policymakers unduly
restrict hybrid plan conversions or impose strict mandates such as
requiring choice or grandfathering for all current workers. Both the
Administration and Congress must recognize that employer-provided
retirement benefits are voluntary. If pension reforms were to impose
additional and unnecessary costs on plan sponsors, this could
ultimately force many plan sponsors to reconsider offering DB plans
altogether and substitute a defined contribution plan that is portable
and has much lower administrative costs. This is an outcome many future
retirees would not see as desirable. Ironically, as more firms exit the
system amidst rising costs, the available pool for PBGC revenues would
eventually decline. Obviously, these outcomes would defeat the intent
of the Administration's proposal, which was to help preserve the DB
pension system.
Thank you for the opportunity to present my views. I would be glad
to answer any questions you may have.
______
Chairman Boehner. I thank the witnesses for your testimony.
I think each of you to some extent or the other talked
about the balancing act that the administration was involved
in, and the balancing act that the Congress will be involved
in, in terms of trying to preserve the defined benefit system
while at the same time ensure that plan sponsors are making the
contributions that, or keeping the commitments, if you will,
that they've made to their workers.
Mr. Stein, you talked about these negotiated agreements for
difficult situations, where employers, employees, and the PBGC
would sit down and come to some agreement.
Do you want to explain that in more detail?
Mr. Stein. Yes, and I should also mention that there was an
opinion column in the Wall Street Journal about a month or two
ago which former PBGC executive director Kanderian wrote with,
I think it was both the pilot and the chief executive officer
of Delta, which is similar to what I was suggesting.
When a company is in bankruptcy, the employer wants to be
able to contribute less immediately because it has cash-flow
obligations.
The employees would like to see the plans continue and the
PBGC doesn't want to see its obligations potentially increase,
and it would be possible, by freezing benefits, by freezing the
PBGC's obligations, to allow some kind of short-term period in
which benefits would continue to accrue but would not be
guaranteed. So long as the employees know that, the employer
might be allowed not perhaps a complete contribution holiday,
but could reduce its contributions.
And in doing that, I think all three stakeholders would be
better off and, under the current system, you can't do that.
It's either terminate the plan or keep it going.
Chairman Boehner. Let me ask a few questions about this.
One is, why wait 'til they get to bankruptcy? Some would
argue that the DRC requirements under the current rules are
actually forcing some into bankruptcy in order to discharge
their responsibility.
And second, if you were to allow this type of negotiated
agreement, what kind of an amortization period would you think
is reasonable?
Mr. Stein. I'm not going to be very good on the details
right now.
I did, in my written testimony, say that this is something
that might be used also outside of bankruptcy, so I agree with
you there.
Just right now, the employer and PBGC have a stark choice:
terminate the plan, transfer liabilities to the PBGC, or
continue the plan, which is often not viable for the employer
if it has to continue with a DRC.
Chairman Boehner. Mr. Porter, in your testimony, you state
that the smoothing of assets and interest rates is crucial for
employers.
However, I think you realize that the administration's
proposal recommends smoothing contributions.
Can you explain why you recommend smoothing assets and
interest rates instead of contributions?
Mr. Porter. The funded status of a plan over the very long
term can be affected very dramatically by short-term changes in
interest rates. History tells us that fluctuations in interest
rates may or may not reflect what the market is. It reflects
whatever happens to be going on at that point in time in the
economy.
Rapid changes in funded status just because there's a
change in the economy that is abrupt changes the perception and
immediately changes what the contribution perhaps might be.
Let me give you an example.
If there was a huge shock to the economy of some sort that
changed dramatically the interest rates for 1 year, and the
next year they were back to normal, smoothing would allow you
to say, ``OK, well, that's there 1-year blip and we won't make
an egregious change simply because there's a 1-year blip,'' but
over time, you would recognize that if that blip became
permanent, it is then fully recognized.
The administration's proposal says, ``We're going to take
that moment blip, momentary blip, and record it as if it's
real.''
Chairman Boehner. But the fact is that the discount rate
that's been used for the last 25 years has been the 30-year
bond.
Mr. Porter. Actually, that's partially true.
If you go back prior to about the mid-1990's, most
companies, the long-term bond didn't apply. If you're a final
pay pension plan, as many of our plans are, the long-term
funding assumptions actually produced better funding than the
30-year bond current minimum that is applied.
The current liability did not apply to most large final pay
plans until just recent years.
Chairman Boehner. In your testimony, you state that credit
balances are not adjusted for market performance.
Mr. Porter. Right.
Chairman Boehner. And I guess the question I've got is,
should credit balances reflect market gains and/or losses?
Mr. Porter. That's a difficult policy decision. Certainly
during the years of 2000 through 2002, a lot of critics have
indicated that credit balances should have been reduced. There
have been other years when interest rates were very high.
You need to have some parallel treatment. Either it's going
to increase and reduce with market value or increase and reduce
with underlying assumption of some sort, but it could work both
ways.
You could actually have some credit balances that would be
higher today and some that would be lower if they were market
adjusted. It would just be different.
Chairman Boehner. The Chair recognizes the gentleman from
Michigan, Mr. Kildee.
Mr. Kildee. Thank you, Mr. Chairman.
Professor Stein, you mentioned two categories, liabilities
already existing for terminated plans, and new liabilities.
How would you suggest we pay for those existing liabilities
for terminated plans?
Mr. Stein. Well, I'm going to say something which I don't
think is very popular, and I don't think many Members of this
Committee probably agree with right now, but I think that as I
suggested, I think part of the problem that we're experiencing
now is a problem that we as a society caused, and it wasn't
simply the defective funding schemes.
I think one of the earlier questions to the first panel
suggested that a lot of this was industry specific and in fact
some of the problems industries are facing reflect deliberate
decisions that we as a nation made, decisions I think which
have been on the whole positive, but which have affected
certain industries very harshly.
The airlines would be one example. We deregulated the
airlines. We allowed discount carriers to come in that did not
have defined benefit plans, paid much lower salaries to their
employees, and created--the promises that the airline
industries made to their employees were quite reasonable when
made, and I think the airlines are to be commended for trying
to meet those promises for so long, but ultimately the
decisions we made to deregulate, which we as consumers have
enjoyed, have hurt those industries and are one of the causes
of the problems that they're now experiencing.
So I think, you know I mean, I would like--you know, I have
faith that if the economy improves, the PBGC's current crisis
will not be quite as severe as it appears right now. I think
there are some things which suggest that the situation in the
PBGC is not quite as bad as the government, the administration
is presenting it.
I think if the economy improves, things will be again
somewhat better, but ultimately I think--and this is where I
think what I'm saying is not something that's politically
easy--I think ultimately, if there are some problems like the
savings and loan association, maybe this is something where the
taxpayers should stand behind the laws which Congress created
and have been on the books for so long.
Mr. Kildee. In other words, where there may be a
governmental cause, maybe there should be a governmental
solution?
Mr. Stein. Mm-hmm.
Mr. Kildee. For example, deregulation was a governmental
factor--
Mr. Stein. Yeah, that's also--
Mr. Kildee [continuing]. Policies would be governmental.
Mr. Stein. Yes, that's also--somebody had--some actuaries
and financial economists have talked about, rather than just
amortizing the former liabilities, the under-funded liabilities
over an extended period of time, that maybe it would be
possible for the government to ensure loans to plans that would
be made through the private sector and would make the plans
whole now, and those loans would be paid off, subject to
government guarantees.
I haven't really decided whether I think that's a good or
bad idea but it's an interesting concept.
Mr. Kildee. Does anyone else on the panel have any
suggestions on that, or comments?
[No response.]
Mr. Kildee. OK. Thank you very much, Professor Stein.
Mr. Kline [presiding]. I thank the gentleman.
The gentleman from Georgia, Mr. Price, is recognized for 5
minutes.
Mr. Price. Thank you, Mr. Chairman.
I, too, appreciate the panel's perspective. I'm interested
in revisiting Ms. Combs' comments in response to my question
about whether or not the administration's proposal addresses
the concerns that they and that we have, particularly as it
relates to oversight.
Would any of you comment please on whether or not you
believe that the proposals that have been put forward allow for
appropriate oversight so that we don't end up right back here
in 10 or 15 years with the same situation--not the solution,
but the oversight?
Mr. Porter. It's not clear to me, from the administration's
proposals, as to what the oversight would be.
There are certain changes in how funding would take place
and how participants would be disclosed, but as far as what the
oversight of the administration would be, I don't believe
there's anything overt in the proposal that would speak to
that.
Mr. Price. Mr. Stein, do you have any comment?
Mr. Stein. Well, there's one aspect in particular where I
think oversight is going to be taken away, which is in the
setting of premiums, and I've heard people complain. I think
it's reasonable for people to say you can't just give that
authority to PBGC, that there really has to be congressional
oversight over that.
And, you know, this is not a competitive insurance market
where there are lots of people competing against PBGC. PBGC has
a monopoly in a sense, and you don't want to give them complete
authority to set whatever rights they think are appropriate.
So there in particular I'm sympathetic to PBGC's need for
more revenue, but I don't think giving PBGC both executive and
legislative authority is prudent.
Mr. Price. Dr. Mulvey?
Ms. Mulvey. I think one of the problems is they're trying
to handle a handful of plans, the unhealthy plans, and they're
kind of penalizing all the healthy ones, so again, I don't
agree whether they're plan does try to do the oversight
properly.
Mr. Porter. If you would allow me, I'd just like to follow
on Mr. Stein's comment.
Under ERISA, there's only two ways that PBGC can fund its
deficit. One is through premiums to employers, and the second
is through investment return.
Recently, the PBGC chose to significantly change its
investment portfolio to be much more conservative so their
assets and liabilities would stay in line.
However, the expense of that was they permanently were to
forego the extra yield that could have come from a better
investment policy. That becomes higher premiums to plan
participants.
It seems inappropriate in our view to vest the same agency
with investment policy and premium oversight.
Mr. Price. OK. I want to step back again a little bit and
maybe be heretical, and try to determine what the fundamental
problem with all of this is, and I want to just ask whether or
not any of you believe that the fundamental problem is the
defined benefit program itself.
Mr. Stein. The defined benefit system has been around for a
very long period of time.
We went from a pay-as-you-go system basically, you know,
when the first defined benefit plans were developed in the late
19th century.
Some of those plans experienced really substantial
difficulty as the workforce aged and when the Great Depression
came, but the system itself has been healthy, I think, and you
know, its survival, its ability to pay benefits to millions of
Americans suggests that there are problems, but they're not
fundamental problems.
One of the concerns that I have about the administration's
proposal is its effect on the healthy employers, which Dr.
Mulvey just referred to.
And I'm not sure, I've been trying to think about this for
the last several months, whether it's appropriate for the
government to consider creditworthiness, but if it is
appropriate to consider creditworthiness, certainly companies
like DuPont should be, if they think it fits their business
model better to be under the old rules, we're not worried about
DuPont dumping its plan on the PBGC.
So if creditworthiness is going to be an operative factor
in the statute, I would like to see it work both ways so that
the firms that we really know are going to be around for the
next 75 years and are going to stand behind their promises
don't have to go to this radical new funding system if they
don't want. I mean, they could. Obviously, you know, they have
choices.
Mr. Porter. Just a quick add-on. Our defined benefit plan,
our principal one for the parent company in the U.S. celebrated
its 100th birthday last year. I don't think it's the program.
We've managed to fund that and keep it healthy for many, many
years.
Thank you.
Ms. Mulvey. I would concur with that. I think the problem
has been a lot of these external factors--the rising
administrative cost by increased regulations and other
factors--but the system itself is pretty healthy.
Mr. Price. Thank you. Thank you, Mr. Chair.
Mr. Kline. I thank the gentleman. The gentleman's time has
expired.
Mr. Payne, would you care to inquire?
Mr. Payne. Thank you very much.
I'm sorry I missed all the testimony, but being an old-
timer, I'm one that certainly supported defined benefit plans,
and with much of what's going on today, really, you know, kind
of puts in doubt people's guarantee for a future.
I just have a question here.
The administration, the plan here, the way I look at it,
penalizes workers by cutting Federal pension guarantees,
penalizes workers by outlawing benefits that protect workers in
event of a plant shutdown. It penalizes workers by restricting
the benefits workers earn at companies with financial
difficulties.
And where workers here, if they had a union that bargained
these benefits with the employers, this proposal, of course,
would interfere with existing collective bargaining agreements.
And so I wonder how--where does that leave the union? Does
it--I mean, it takes away from previously guaranteed
provisions?
Does anybody want to take that on?
Mr. Stein. Yeah. I think the government's proposals are
not--don't have protection of existing employee benefit
expectations as one of its sort of preeminent guiding lights.
In my written comments, I make numerous suggestions about,
you know, how we can move to better rules while preserving
employee expectations, or at least where there is some
reasonable transition period.
But yes, I think--I think the--I think if the proposals
were leavened by a greater consideration for employees and to
some extent for employers, they would be better proposals.
Mr. Porter. I think that the restrictions proposed by the
administration is one way.
Since it is not the government that supports pension plans
that fail, it is other companies and other organizations that
have their own plans to support the plans that fail, there
needs to be an adequate balance somehow between what has been
appropriately and legitimately bargained between an
organization and their employer and the fact that there are
many other participants to this equation who were not party to
that negotiation.
So what that balance is, I think we can all work together
toward appropriate conclusions and how it would be, whether the
administration's proposal or others, but there needs to be a
balance somehow between those who guarantee ultimately pension
plans that fail and those that fail.
Mr. Stein. One of the proposals specifically about plan
shutdown benefits that I make in my written comments, I guess
it has two aspects.
One is the current scheme should remain through the end of
collective bargaining agreement terms, and the second proposal
was that we investigate the establishment of a separate
insurance fund for plan shutdown benefits.
If you want to have a plan shutdown benefit, you would pay
risk-based premiums to the PBGC for those particular benefits.
Mr. Payne. Thank you. Thank you very much.
Mr. Kline. I thank the gentleman.
Mr. Tiberi, would you care to inquire?
Mr. Tiberi. Thank you, Mr. Chairman.
I think the Chairman, Chairman Boehner put it right when he
said it was a balancing act as we move forward.
I want to get your thoughts on this issue.
I have a number of employers in my Central Ohio district
that are concerned. They have funded their plans regularly.
They're healthy plans. And they're concerned that what we do
here might cause them to do something detrimental to their
plans and go to a contribution system rather than a defined
benefit system.
Can I get your thoughts, the three of you, on what your
thoughts are on what we could do here in terms of increasing,
or PBGC increasing their premiums to healthy employers, healthy
employer plans, and what that would mean, just your thoughts,
each one of you?
Mr. Porter. May I get a clarification? Are you specifically
talking about the PBGC premiums or the funding rules?
Mr. Tiberi. The PBGC premiums.
Mr. Porter. PBGC premiums, by themselves, add up to a lot
of money.
Individually, especially the base premium doesn't seem like
that much, but to the extent that the administration's proposal
causes a significant increase in the amount of unfunded that
plans have, or plans that are now fully funded by any other
economic measure to become apparently unfunded, those plans
would take on substantial increases in premiums.
And I can't speak for individual plan sponsors as to
whether those premiums by themselves would break the bank, but
it becomes a contributing factor in decisions of plan sponsors.
And the issue also is, to the extent that plan sponsors are
the ultimate payor of plans that fail, there is a concern,
right or wrong, that the last one out pays the bill, and I
think that needs to be addressed.
Mr. Tiberi. Thank you.
Mr. Stein?
Mr. Stein. It's a complicated question.
Again, I think the base funding, the base premium amount,
$30 per premium, which the government is proposing, I don't
think is unreasonable.
Having said that, I agree with Mr. Porter that there is a
problem with the premiums that will be risk-based, and one of
the things that, again, I discuss in my written comments, is
the possibility that we might use those premiums as a separate
fund within the plan that would be used simply if the plan
fails to provide for the guaranteed benefits, not for other
benefits, and thereby improve the funding of the plan with the
money you're paying out.
I think there is a problem. I think there's an inherent
problem in the way PBGC is structured. Your premium pays for
two things. It pays for the risk that your plan will terminate.
If you're a healthy plan, you're also subsidizing, as a
number of people have said today, the plans that aren't well-
funded at the moment, and I don't think that that really is--
you know, that the universe of sponsors of healthy defined
benefit plans doesn't seem to me to be the right universe to be
covering that subsidy.
If we want to make it, and I think we should want to make
it, we should make it as a society, rather than simply burden
people who responsibly fund their defined benefit plans.
Ms. Mulvey. The PBGC premiums, while the percentage
increase looks large, they are very small in terms of
increases, and by themselves, if nothing else was added in
terms of cost, it wouldn't be a big issue.
But i think those premium increases, along with all the
other issues that we've talked about, will hit those industries
like manufacturing, which will have a difficult time paying for
those increased costs.
Mr. Tiberi. Mr. Porter, you mentioned the issue of
investments and conservative investments.
Can all three of you touch upon how over a 10-year period
moving toward a more conservative approach to investing will
have an impact on PBGC--your thoughts?
Mr. Porter. We can--I can look at history as an example.
Pension funds for most employers are diversified. Studies
indicate that diversity is the best security, and those funds
have been earning well in excess of most of the plans'
assumptions for long-term assumptions, over many years.
So if you were today to immunize your portfolio so that you
invested in a way that exactly matches the liability proposed
by the administration--which by the way is not physically
possible--you would have conceded that your plan going forward
would earn something close to five or five-and-a-half percent,
maybe six, over the long term, and yet it's hard to find too
many successful pension plan trusts that have made that little
in any reasonable length of, period of time.
So that foregone investment, if 9 percent is a reasonable
long-term assumption--some people have challenged whether it
is, but if you look at history, it's hard to find a period over
the last thirty years where that hasn't been true--that's 3
percentage points, that's 3 percentage points that have to be
funded by the plan sponsor instead of achieved through
investment.
That causes the plan to increase precipitously relative to
the cost of a defined contribution plan.
Mr. Tiberi. Thank you.
Mr. Kline. The gentleman's time has expired.
The gentleman from New Jersey, Mr. Andrews, is recognized
for 5 minutes.
Mr. Andrews. Thank you, Mr. Chairman.
I thank the witnesses, and I apologize for not being
present for your testimony, but I appreciate you preparing it
in written form so we can review it.
This will come as a surprise to some people in this room,
but there are some people who do not follow the yield curve
debate in America, who don't--
[Laughter.]
Mr. Andrews [continuing]. And what's also not surprising is
that most people would think that this is a very arcane and
abstract issue. I do not think that it is.
I think that the kind of interest rate assumptions we write
into this law are critical to the question of whether people
maintain defined benefit plans or not, because it has been my
experience, and as I said to the earlier panel, in listening to
employers and union leaders and experts in this field, such as
actuaries across the country, that there is a relationship
between volatility and maintenance of these plans.
The more volatile your assumptions are, the less likely you
are to maintain one of these plans, and as I said earlier, as
someone who has a bias in favor of maintaining these plans, I
look at the yield curve debate as rather critical to that
answering of that question.
I know that each of you has had comments about the yield
curve proposal in your written testimony.
We heard from the earlier panel, the administration
defended its proposal essentially in two ways.
The first was that, taken as a package, they argue that
their reforms in the defined benefit law make defined benefit
plans more desirable and will enhance their retention and
perhaps even growth, so they say that you have to look at the
other issues, like pre-funding and so forth, to evaluate the
question.
The second argument they make is that the curve could be
done by an actuary on one spreadsheet, I think the comment was.
I think that all three of you think that they're wrong. I
know that Mr. Stein was--his comments really focused on the
small business aspect of this, about the burdens.
But if you think they're wrong, why are they wrong? Why
should we adopt something other than the administration's yield
curve proposal in this instance?
And I would ask each of three of you to answer the
question.
Ms. Mulvey. I think the problem is if the yield curve were
implemented right away it would hurt those that have older
workforces, older than average, and many of these plans are
well-funded already that they're aiming to raise the cost to.
So I think that the system was working the way it was in
terms of the interest rate, and why fix something if it's not
broke?
Mr. Andrews. I think you also commented on the long-term.
You say the volatility also would make it more challenging for
firms to develop reliable long-term financial and/or strategic
plans for their companies.
So it's not simply the fact that well-funded plans today
would be perhaps forced to make contributions that they ought
not make. There's a longer-term consequence too, isn't there?
Ms. Mulvey. Yeah, and that has to do with more the spot
rate versus the 4-year average than the yield curve itself.
Mr. Andrews. OK. Mr. Stein?
Mr. Stein. I'm a little bit different. I'm not against use
of the yield curve in appropriate situations.
The problem that I have with the yield curve is it's useful
for the snapshot we use in today's deficit reduction
contribution.
It's useful if we're worried about a plan terminating, and
more accurately measuring liabilities, even given the, I think,
very insightful critique you made of how it's not really--you
know, the yield curve is going to be very sensitive to changes
in the workforce, which the administration proposals, I think,
assume is more or less static.
But most employers, I think we can look at their plan more
as an ongoing enterprise, and we don't have to be worried about
minute-to-minute accurate snapshots, and to the extent that
we're going to in the name of some kind of, you know,
theoretical purity use the yield curve and increase volatility,
I think that's a mistake.
Mr. Andrews. OK. Mr. Porter?
Mr. Porter. I have three issues.
One is what happens in periods of high interest rate? I'll
explain that in a second.
The second is, it's not really always accurate.
And the third is, we take exception to the administration's
view that yield curve is used for virtually all financial
transactions, or many of them.
If you look back in the early 1980's and late 1970's, when
interest rates were double digit, and there were periods of
time when the yield curve was inverted, a legacy pension plan
with lots of retirees would have been using a discount rate
well in excess of 15 percent in some of those years.
The funded status, to be fully funded would require almost
no assets, less than 50 percent--excuse me--about 25 percent of
what we would require as full funding today for the same plan.
If you take a plan--I've done an analysis internally, which
needs to be done more broadly through, but it just challenges,
it's one person's analysis, but if you took a fully funded plan
in the mid-1970's and followed these rules, as interest rates
spiked during the early 1980's and then started a gradual
decline over the next decade or two, the plan would not have
been permitted to make contributions in six or seven of those
years as interest rates were going up because it would have
been considered grossly over-funded.
Mr. Andrews. Which is certainly counterproductive to--
Mr. Porter. Yeah. So contributions that were actually made
in that period would not have been made. Plans would have had
less assets. Going into the period when pension trusts earned
12, 13, 14 percent compound, those assets would not have been
there earning them, so pension plans would be less well-funded
today.
Those plans would have then had to make contributions in
the 1990's, when the economy was starting to weaken, to make up
for the foregone contributions--
Mr. Andrews. Your point is borne out by the fact that
within the last 25 years, we've seen a prime rate as high as
17, and as low as what, three-and-a-half or something.
Mr. Porter. That's right.
Mr. Andrews. I mean, it could certainly happen again.
Mr. Porter. My second comment is that we talk about
accuracy, but if you look at what the available marketplace is
for AA corporate bonds, it's pretty thin, and the Treasury goes
through a 90-day period to get enough points, but there's a lot
of points where there are no assets.
Our plan has an average duration, an average duration of
about 12 years, and there are very few investments out there
that could be used to match that cash-flow, so we would have to
rely on investments other than that to actually--you know, we
can't actually duplicate on a pure basis that particular
number.
And the third is, there was a comment made that everybody
does yield curves for everything else.
And it's true the yield curve is used for certain financial
purchases, but corporations use other things, like return on
equity when making decisions.
When we decide to build a plant or add to a production
somewhere in the world, we're not looking at the yield curve.
We've looking at how will that plant, what will it return in
relation to our total cost of debt, which includes cost of
equity as well as the cost of borrowing, and it's a much higher
rate, what is used for the threshold for determining whether to
build a plant or add a production line.
Mr. Andrews. I read the Chairman's speech from last
September on this subject, and my sense is that the yield curve
does not fit his principles that he articulated, either.
I thank you very much for your testimony.
Mr. Porter. Thank you.
Chairman Boehner. I appreciate my colleague pointing that
out.
[Laughter.]
Chairman Boehner. The Chair recognizes the gentleman from
Minnesota, Mr. Kline.
Mr. Kline. I thank you, Mr. Chairman.
I just want to say that I'm shocked--shocked--to learn from
my colleague, Mr. Andrews, that not all of America is following
the yield curve debate.
[Laughter.]
Mr. Kline. I find that remarkable, and I will talk to him
after the hearing to find out if that pandering to the Chairman
works out for him.
[Laughter.]
Mr. Kline. I'm certainly willing to try that.
Mr. Andrews. It really doesn't.
[Laughter.]
Mr. Kline. I suspected that might be the case.
I was very much--we had wonderful hearings, and as the
witnesses know and all my colleagues know, that discussion, the
debate has been going on for some time about how do we in fact
resolve the retirement security crisis and make sure that in
whatever we do, that the retirees, the PBGC, the taxpayers, the
employers are all respected in this.
And I've told the Chairman and my colleagues that if we end
up at the end of the day with a policy that doesn't do that,
that for example, puts companies into bankruptcy, then we have
failed in our effort to create some good policy.
And I was intrigued with Professor Stein's approach of
recognizing that we have some, if I could call them legacy
problems that we may need to look at one way, and in the future
in another way.
I have a couple of technical questions that I've been
talking to staff about. They happen to be for Mr. Porter. I'd
like to ask those, and then I'll be able to yield back.
Mr. Porter, if credit balances are completely eliminated,
will companies still have the incentive to make additional
contributions to their plans?
Mr. Porter. That's a two-edged sword.
Mr. Kline. As are they all, sir.
Mr. Porter. The administration's proposal, when interest
rates are low, permits companies to make very large
contributions that will be totally unnecessary if interest
rates go up.
If interest rates are high, it cuts back the ability to
make contributions that might well be needed later.
So there is flexibility, provided the plan is fully funded
by the administration's yield curve proposal.
If a plan is less than fully funded and is facing annual
contribution requirements under the proposal, the only
flexibility the plan sponsor has is to contribute a one-time
contribution to bring it to full funding or above. Otherwise,
they have no flexibility.
Let me give you a quick example.
If you had to make a $100 contribution every year for the
next 5 years, and you would be fully funded at the end of the 5
years, current law would let you say, I'm going to put 300 this
year, skip a couple years, put a couple hundred in. At the end
of 5 years, you're fully funded, just like you would be if you
met the minimum funding requirement.
This proposal says I put $100 in, and supposed to put it
in, well, I'm going to put 200 this year, I still have to make
my 100 next year, still have to make it the next year, I don't
get credit for that extra $100 until the fifth year.
So a company that is looking at variability of cash-flow
and has a minimum annual contribution will not be able to have
any flexibility about when it makes those contributions and
will therefore probably choose not to make an extra
contribution if I'm going to have to make the same contribution
next year.
Mr. Kline. Thank you. And let me just continue with you on
that on another somewhat technical question having to do with
tax policy.
I think in your testimony you suggested repealing the
excise tax on non-deductible contributions; is that--
Mr. Porter. That's correct.
Mr. Kline. Have I got that right? And why do you think we
should do that? Why is that tax unnecessary?
Mr. Porter. It all depends on what else you do.
[Laughter.]
Mr. Porter. Let me just paint a scenario for you.
We've heard some talk about legacy plans, and certainly the
DuPont pension plan, we have a lot of retirees in our plan, so
it would qualify by some definitions as a legacy plan, very
well-funded.
We have several provisions in the tax law that are a
problem. One is this 25 percent cap on contributions. One is
the excise tax on extra contributions.
As the interest rates were declining over the 1990's, we
were not permitted to make a contribution. My management
actually came to me and said, ``Ken, is it now time to make a
contribution?'' And I said, ``You can't because you'd be
charged an excise tax.''
So if there's nothing else done, the excise tax did keep us
from making a contribution.
The 25 percent cap, well, we blow through that right away.
We make a normal contribution of normal cost using the discount
rates the administration has proposed, because we have 80
percent plus of our liability is with respect to people already
retired, 25 percent of payroll is small compared to our pension
liability. Twenty-five percent of payroll gives us nothing.
If we were to contribute anything other than the absolute
minimum, we would probably lose our defined benefit our defined
contribution deduction as it is.
So those provisions, taken as a whole, are very restrictive
in the ability of a company with a large pension plan to make
any contribution other than the absolute minimum.
Mr. Kline. Thank you.
Mr. Chairman, my time has expired.
Chairman Boehner. Let me thank the witnesses for your
excellent testimony.
We've had a number of hearings over the last several years.
Matter of fact, I could probably talk about the last 6 years
that we have had hearings looking at the condition of our
pension system, and I'm looking forward to, in the coming weeks
and/or months, introducing our pension proposal, and looking
for swift action this year on an overhaul of our defined
pension benefit rules.
So I want to thank all of you for your help and look
forward to seeing all of you again.
This hearing is adjourned.
[Whereupon, at 12:38 p.m., the Committee was adjourned.]
[Additional material submitted for the record follows:]
Statement of Hon. Charlie Norwood, a Representative in Congress from
the State of Georgia
Mr. Chairman, I thank you for holding today's hearing to thoroughly
examine the Administration's policy proposal to reform the voluntary
single-employer private pension system. This Committee has held
countless hearings over the past two years to analyze this issue, and
your leadership in providing direction to the Administration regarding
the American retirement security crisis is laudable.
It is a well-known fact that American workers are staring down a
number of crises regarding their retirement security. The Pension
Benefit Guarantee Corporation is facing a record $23 billion debt,
fewer employers are offering defined benefit pension plans, and some
have even frozen or terminated their pension plans altogether.
In such a climate of uncertainty, Mr. Chairman, it is no wonder
that employees continue to fret for their financial future. After all,
folks who've worked for a company their entire lives depending on the
promise of a generous private pension can no longer simply trust that
their needs will be met. Thousands of United Airlines employees who
lost their pensions last year can tell you that.
Mr. Chairman, this Committee has a responsibility to ensure that
what happened to hard working employees of United Airlines does not
happen again. We must therefore provide employers with the tools they
need to continue financing and funding these defined benefit pension
plans, and this hearing designed to vet the Administration's reform
proposal is a good place to start.
It is imperative that Congress and the Administration work together
to provide employees reaching their golden years with peace of mind
regarding their retirement security. But it is just as important, Mr.
Chairman, to ensure that our younger employees who will spend the next
10, 20 or 30 years in the workforce can benefit from a strong, flexible
defined benefit pension system on solid financial ground.
I look forward to the testimony from our distinguished panel of
witnesses, and hope that we can all gain a better understanding of how
Congress and the Administration can move forward to ensure that our
workers retire with dignity and security.
Thank you Mr. Chairman, and I yield back.
______
Statement of Hon. Jon C. Porter, a Representative in Congress from the
State of Nevada
Good morning, Mr. Chairman. Thank you for convening the Committee
on Education and the Workforce for this most important hearing. I also
wish to extend my appreciation to this panel of witnesses for sharing
their experience and knowledge on the impacts of reform on our current
pension system. Ensuring that Americans are financially secure in their
retirement should remain one of the highest priorities of this
committee and this Congress.
As an increasing number of Americans prepare for a retirement that
will last significantly longer than past generations, our job of
examining the pension security of all Americans becomes increasingly
important. While seeking to create secure retirements for all
Americans, we must ensure that the structure of our pension system will
not negatively impact the American taxpayer. Providing the Pension
Benefit Guarantee Corporation with the financial footing that will
allow continued assurances of the strength of pension programs requires
an intense study of the vulnerabilities of our current system, and the
issues that pension plans have faced in recent years.
I would also like to mention, Mr. Chairman, that as we move forward
with the reforms proposed by Chairman Boehner and by the Bush
Administration, we must seek out ways of encouraging American workers
to gain a more comprehensive understanding of their retirement futures.
The need for adequate education on and understanding of the financial
needs of retirees has become paramount. As we look at means of
augmenting the dissemination of this kind of knowledge, we must
acknowledge that significant numbers of Americans lack the essential
knowledge to ensure that their retirements are not fraught with the
distresses of poverty.
Again, thank you Mr. Chairman for convening this necessary hearing.
I am sure that the insight of these witnesses will better equip all of
us who sit on the committee to better comprehend the situation that
this Congress faces in bringing needed reforms to our pension system.
______
Statement of the Society for Human Resource Management, Submitted for
the Record
Chairman Boehner and Ranking Member Miller:
The Society for Human Resource Management (SHRM) applauds your
collective efforts over the past several years to craft legislation
that will ensure the integrity of the defined benefit (DB) pension
system and the solvency of the Pension Benefit Guarantee Corporation
(PBGC). SHRM and its members remain committed to a flexible pension
system that meets the retirement needs of its workforce and the
financial goals of its organizations. Specifically, SHRM wants to make
sure that pension promises are kept and pension plan requirements are
equitable yet effective.
The Society for Human Resource Management (SHRM) is the world's
largest association devoted to human resource management. Representing
more than 190,000 individual members, the Society's mission is to serve
the needs of HR professionals by providing the most essential and
comprehensive resources available. As an influential voice, the
Society's mission is also to advance the human resource profession to
ensure that HR is recognized as an essential partner in developing and
executing organizational strategy. Founded in 1948, SHRM currently has
more than 500 affiliated chapters and members in more than 100
countries.
As public and private employee benefit plan sponsors, managers and
administrators, HR professionals are intimately involved in all aspects
of pension plan management and administration. We appreciate this
opportunity to share with you our thoughts on the Administration's
proposal to strengthen funding for single-employer pension plans and
offer the following specific comments on the Administration's proposal:
Improve Disclosure
The Administration proposes to provide increased information about
a plan's funding status and timelier plan funding information. SHRM
supports increased disclosure to plan participants on plan funding and
financial status but remains concerned that some information or
actuarial calculations may be overly complex for both plan sponsors and
plan participants. SHRM is worried that complex actuarial assessments
or assumptions, without comprehensive and lengthy explanations, may
lead to confusion. Such false impressions or misunderstandings about
plan solvency could generate unwanted economic market fluctuations,
inconsistent industry information, and undermine confidence in the
plan's solvency.
Determining Liabilities
The Administration proposes to base the interest rates used for
present value calculations for pension funding obligations on a yield
curve valuation. SHRM supports using a more accurate valuation method
as it provides a better indication of a plan's obligations. However, we
are hesitant to fully support the yield curve valuation method because
it potentially introduces increased volatility in assessing plan
liabilities. Plan liabilities would become dependent not only on
fluctuations in interest rates but also on changes in the shape of the
yield curve and on changes in the duration of plan liabilities. This
type of volatility in pension obligations undermines employers' ability
to predict and budget their costs and has already been a significant
deterrent to organization's retaining DB plans as a retirement plan
option. SHRM believes there are alternate valuation models that
approximate the effect of a yield curve without adding as much
complexity to the calculations or actuarial volatility; which if
continued would maintain the current trend of employer's preferences
for other types of qualified pension plans.
Minimum Funding Credit Balances
The Administration proposes that the minimum required contribution
to the plan for the year would be equal to the sum of the applicable
normal cost for the year and eliminates the alternative minimum funding
standards. SHRM supports employer flexibility to assist in the
management and administration of pension plans and would therefore
encourage policies that would permit credit balances. Furthermore, the
elimination of the alternative funding standards limits funding
flexibility as well as the need for a funding standard account.
Although making larger than required contributions would not directly
reduce a sponsor's future minimum funding requirements, SHRM believes
the additional contributions could accelerate the date when the plan's
assets reach its funding target (eliminating the need for amortization
payments), reduce the amount of otherwise required new amortization
payments, remove certain restrictions on plan benefits, and reduce PBGC
premiums.
Tax Deductible Contribution Limits
The Administration proposes to permit funding on a tax deductible
basis to the extent the plan's assets on the valuation date are less
than the sum of the plan's funding target for the plan year.
SHRM supports the Administration's proposal to increase the spread
between the minimum funding target and the maximum tax-deductible
level. This approach provides a way for organizations to stabilize
contributions from year to year. SHRM also suggests that considerations
be made to allow limited access for post-retirement medical benefits
under IRC Section 420. SHRM believes this option would increase an
employer's flexibility in providing post-retirement benefits.
Phased Retirement
Although not addressed in the Administration's proposal, SHRM
believes Congress should create a formal phased retirement structure in
order to assist employers in workforce replacement challenges
anticipated as a result of the impending retirement of the baby boom
generation. A nontraditional work schedule with retirement
flexibility--phased retirement--will be a key workplace issue in the
21st century.
Contributions During Economic Prosperity
The Administration's proposal strives to provide employers with
additional flexibility while meeting the plans financial obligations.
SHRM believes organizations should be permitted to make additional
contributions during times of economic prosperity. Providing this
option for employers sets an example for ``planned responsible saving''
and provides organizations with additional flexibility during times of
unforeseen economic downturn.
SHRM supports Administration and Congressional efforts to encourage
continued and new participation in the defined benefit system as well
as measures to ensure that plans fully meet their funding obligations.
SHRM especially appreciates the Administration's proposal to simplify
the current funding rules by essentially establishing one set of
required calculations.
SHRM believes that government shares responsibility with Americans
to achieve adequate retirement income, and encourages Congress to
continue supporting a voluntary employer-provided retirement system for
employees. We look forward to working with you in the months ahead to
develop a long-term solution that will ensure the integrity of the DB
pension system and the solvency of the PBGC. Thank you.
Respectfully,
Susan R. Meisinger, SPHR
President and Chief Executive Officer
______
Statement of the ERISA Industry Committee, Submitted for the Record
Mr. Chairman and Members of the Committee, thank you for the
opportunity to present the views of The ERISA Industry Committee (ERIC)
on the Bush Administration's proposals to reform voluntary single-
employer defined benefit pension plans.
ERIC is a nonprofit association committed to the advancement of
the employee retirement, health, incentive, and benefit plans
of America's largest employers. ERIC's members provide
comprehensive retirement, health care coverage, incentive, and
other economic security benefits directly to some 25 million
active and retired workers and their families. ERIC has a
strong interest in proposals affecting its members' ability to
deliver those benefits, their cost and effectiveness, and the
role of those benefits in the American economy.
In recent years, the House Education and Workforce Committee has
increasingly taken an active role in conceiving and moving to enactment
legislation that improved voluntary retirement savings. For example,
provisions of the Small Business Job Protection Act of 1996 (P.L. 104-
188), the Taxpayer Relief Act of 1997 (P.L. 105-34), the Economic
Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), and the
Pension Funding Equity Act of 2004 (P.L. 108-218) supported retirement
savings both by increasing opportunities for savings and by providing
more rational rules for employers who voluntarily provide retirement
plans to their employees.
Making EGTRRA Reforms Permanent
The Committee's recent leadership stands in contrast to legislation
enacted during the 1980s when a host of limits, restrictions, and
complicated rules were imposed on retirement savings plans as well as
other employee benefit plans (see attached chart).
As a result of some of the changes enacted during that decade,
funding for defined benefit pension plans was substantially delayed
because employers' ability to project and begin to pay for future
benefits was constricted through a series of new and reduced limits.
Title VI of EGTRRA included provisions that partially reversed some of
these funding constrictions, but the improvements will expire in 2010
unless extended by Congress. An extension of these modest improvements
in pension funding was included in the President's budget. We urge that
when this Committee work toward ensuring that the provisions improving
pension funding be made permanent.
The Impact of Reform
The Administration has put forward a proposal to re-invent the
rules governing voluntary defined benefit pensions. This sweeping
proposal has some elements with which we agree but also contains many
elements that will reduce retirement security by making it far more
difficult for employers voluntarily to sponsor defined benefit pension
plans.
The future of voluntary employer-sponsored defined benefit plans
now is in Congress's, and this Committee's, hands. Whether at the end
of the day employers are provided with a voluntary system that
encourages them to establish, maintain, and fund pension plans--or
whether they are faced with a system that discourages and even
penalizes such actions will depend on the ability of Congress and
stakeholders to find the right balance of rules and opportunities,
risks and protections.
No system can be totally risk free and full proof. Any workable,
sustainable system needs to balance legitimate concerns for security
with equally legitimate concerns for business and economic
competitiveness and flexibility.
This is an important conversation, and ERIC welcomes the
opportunity to work with the Committee and the Administration to build
a more robust voluntary defined benefit pension system.
A Sound PBGC
ERIC supports a soundly financed Pension Benefit Guaranty
Corporation. As the PBGC has stated, the agency faces long term issues
but does not face a liquidity crisis. It has on hand sufficient assets
to pay trusteed benefits for many years into the future. Moreover, when
it trustees a plan, its asset base grows. Potential issues regarding
the PBGC are long term issues.
In that regard, we note that of the $23 billion deficit published
by the agency at the end of 2004, $17 billion (or nearly three-
quarters) was due to claims that had not yet been received by the
agency--called ``probable'' claims. Probable claims are those the
agency expects to receive in the near future, although not necessarily
in 2005. Thus, airline plans recently trusteed by the PBGC most likely
are already included in this deficit calculation and do not increase
any reported deficit. (See chart)
The Administration Proposal
The Administration proposes to replace the current-law long-term
and short-term funding rules with funding rules based on spot measures
of funded status as well as on the assumed financial health of the
sponsoring employer; to modify disclosures made to the general public
and to participants; to substantially increase premiums paid to the
Pension Benefit Guaranty Corporation as well as the number of employers
who pay a variable premium; and to restrict benefits available to
participants in certain circumstances.
Permanent Interest Rate
ERIC strongly supports the Administration's proposal to provide a
permanent interest rate that is based on corporate bonds, even though
it disagrees with the specific construction of that rate chosen by the
Administration (i.e., a yield curve). Uncertainty over the applicable
interest rate has caused many plans to be frozen over the past few
years and impeded sound business planning. Providing stability in this
key assumption is critical. Long-term corporate bond rates enacted by
Congress for 2004 and 2005 provide a realistic picture of plan
liabilities and reflect a very conservative estimate of the rate of
return earned by pension trusts. The 2004-2005 solution should be
enacted on a permanent basis.
Deductible Contributions
ERIC also strongly supports the proposals such as those put forward
by the Administration that will increase limits on deductible
contributions so that employers can fund up in good times and build
cushions that will help them weather downturns. There are several
proposals put forward by the Administration, Members of Congress, and
stakeholders that deserve consideration. The specific provisions that
will be most effective, of course, will depend on the final structure
of the underlying funding rules chosen by Congress.
Disclosure
As stated in its principles, ERIC also agrees that more meaningful
and current disclosure can be provided to participants, although we
believe substantial modifications to the Administration's suggestions
are needed.
Key Concerns
Volatility and Lack of Predictability
The current law long-term funding rules, which are based on long-
term assumptions, allow companies to know well in advance what their
funding requirements will be, and those requirements remain relatively
stable over time. The current law deficit reduction contribution
(short-term) rules, which are based on a rate averaged over four years,
also allow companies to know at least a few years in advance when they
may become subject to faster funding requirements.
Because it is based on spot measures of a plan's funded status, the
funding construction proposed by the Administration eliminates a
company's ability to predict its future contribution requirements.
Under the Administration's proposal, a large plan's funded status also
can swing back and forth between over funded and underfunded from year
to year based solely on external macro-economic factors such as
interest rates and short term market performance. The down swings can
place cash calls on a company in the billions of dollars.
Pension plans are provided on a voluntary basis, and few companies
will be able to tolerate that much risk exposure, especially in
something that is not integral to their business product. To abate (but
not eliminate) this risk, a company would have to radically overfund
its plan and/or modify its investment allocations--and both of these
make the plan far more expensive. At a minimum, benefits earned by
participants will be reduced to keep overall costs level; in many
instances, employers will be pushed out of the system.
We believe instead that the current-law long term rules should be
made more effective and that the DRC rules should be made both more
effective and less volatile.
Procyclical Impact
The current law DRC rules are designed to delay faster contribution
requirements triggered by a normal recession until the economy has
begun to recover. By contrast, the Administration's spot-rate scheme
would exacerbate any downturn by imposing sharp cash calls well before
recovery is under way.
The proposal ignores the fact that some plans will become somewhat
underfunded during an economic downturn--and that this is normal and
poses no risk to the PBGC. By designing rules that essentially require
plans to be 100% funded at all times, the Administration has set a bar
that is neither rational nor needed in the real world.
In addition, the Administration imposes an expansive definition of
liability on any company that drops below investment grade. At a
minimum, this part of the proposal is a strong incentive for employers
not to sponsor defined benefit plans in the future. Besides the fact
that many questions have been raised about how the rating companies
operate, the proposed rules may in fact trigger the problems they are
trying to resolve. They may trigger a plan termination--and, in the
worst circumstances, cause the demise of the company itself.
Structuring pension liabilities according to a company's credit rating
will cause some companies to be downgraded, increasing their cost of
doing business. For a company that is climbing to investment grade, the
climb is likely to be much more difficult.
Many, many companies have been or will be below investment grade
from time to time and will never terminate a plan that is trusteed by
the PBGC. The proposal to base liability calculations on a sponsor's
credit rating is like an ineffective and harmful medical test that has
too many ``false positives.''
Complexity and Lack of Accountability
The Administration proposes to require use of a corporate bond
yield curve that would be constructed monthly by Treasury staff. This
is an extraordinary transfer of authority from Congress to agency
staff.
Moreover, available markets in the sections of the yield curve that
are most critical to most pension plans are thin--thus the staff must
interpolate interest rates at those points. This will be very difficult
for Congress to monitor, but it can have enormous impact on pension
plan funding requirements.
Even though the Treasury will produce a single-page spread sheet of
its yield curve, application of the curve is, in fact, complex.
Estimates must be made decades into the future regarding the ages at
which individuals will retire and the type of benefit distribution they
will choose. Application of a yield curve to lump sum distributions
also is complex and will be confusing to participants. The current law
interest rate also is used in numerous other provisions of pension
law--and a yield curve may not be suitable for all of these.
Use of a yield curve will unnecessarily increase the volatility of
pension funding since both the interest rates in the curve and the
curve itself will fluctuate.
In addition, while the Administration proposes interest rates
theoretically tailored to each plan's expected payout, it would still
require all plans to use the same mortality tables, creating for some
plans a substantial imbalance.
Disincentives to Pre-fund
An employer who makes extra contributions will be in a worse
economic position than an employer who does not if contributions above
minimum requirements cannot count as pre-funding of future
contributions. The Administration's proposal to eliminate credit
balances should not be enacted. Available credit balances should,
however, be adjusted if the underlying value of the assets decreases.
This preserves a key incentive for employers to pre-fund their pension
obligations during good times while eliminating a flaw in the current
law that could allow a plan to use a credit balance even though poor
investment results had erased its value.
Excessive Premium Taxes
The proposal has been scored as requiring plan sponsors to pay a
startling $26 billion in additional premium taxes over the next ten
years. Moreover, the proposal would index the flat-rate premium tax to
wage growth (regardless of whether the agency needed the funds) and
would allow the PBGC itself to set variable rate premium tax levels.
A premium tax increase of this size is not warranted. Moreover,
both the indexing and the transfer of authority to the PBGC are
inappropriate. Section 4002 of ERISA, states that the PBGC is to
``maintain premiums. . .at the lowest level consistent with carrying
out its obligations. . .'' Automatic indexing, which would occur
whether or not the PBGC needed the money, is inconsistent with this
directive. It is wholly inappropriate for the PBGC to set the variable
premium tax levels. Premium tax levels must balance the financial needs
of the agency with the social goals of supporting a voluntary private
pension system. Only Congress has the breadth of view and the
recognized authority to make these judgments.
Principles Regarding Pension Funding and Financial Disclosure to
Participants
At a time when members of the Baby Boom cohort are entering their
retirement years, the government should assist employers who
voluntarily sponsor retirement plans for their employees. Meeting the
nation's retirement income needs is an important public policy
objective that cannot be met by reliance on government, employers, or
individuals alone. Employers offer several different forms of
retirement savings vehicles, among them traditional and hybrid defined
benefit pension plans in which employees accrue benefits without
incurring the risk of investment loss. These plans remain vital to the
ability of individuals to achieve financial security in retirement.
ERIC believes the Committee's actions should be based on the
following principles governing pension funding and financial disclosure
to participants:
Regulatory Environment: The federal government must create a
regulatory environment that encourages the establishment, continuation,
and long-term viability of defined benefit pension plans by providing
plan sponsors with the certainty they need regarding--
* the interest rate used to calculate their liabilities;
* rules that support predictable and stable plan funding
* the validity of cash balance and other hybrid plan designs;
In addition, rules governing pension plans must balance the
interests of participants and of employers who voluntarily sponsor
defined benefit plans. They must recognize the differences and need for
flexibility among employers in plan design and the varying needs and
interests of different workforces. Specifically:
* Legislation must be enacted as soon as possible that establishes
a realistic and permanent interest rate assumption that appropriately
measures the present value of pension plan liabilities and that, with
an appropriate phase in, is applied to the minimum amount of any lump-
sum distribution that a pension plan makes. The failure to change the
current rate applicable to lump sums has resulted in lump sum
distributions that are outsized relative to economic reality and the
plan's funded status and has created an artificial incentive for
participants to take their benefit in a lump sum.
* Pension funding standards must strike the appropriate balance
that encourages employers both to establish and maintain defined
benefit pension plans and to fund the plans on a reasonable and
appropriate basis, thus protecting participants. This is essential to
protecting the financial health of the pension system and the business
vitality of plan sponsors. For example, legislation imposing additional
requirements or benefit restrictions on plans less than fully funded
should not be triggered by the credit rating of the sponsoring
employer. This measure creates too many ``false positives.'' It would
impose unnecessary burdens on a large number of employers who otherwise
are not likely to terminate their plans, making their business recovery
more difficult and in some cases triggering the very plan termination
that the funding rules should seek to avoid.
* Employers must not be discouraged from developing new plan
designs that meet the changing needs of the current and future
workforce. Legislation must be enacted that confirms the legality and
facilitates the adoption and continuation of hybrid plans so that
employers will be more likely to continue to offer pension plans.
* The Pension Benefit Guaranty Corporation (PBGC) must align its
objectives with those of employers and participants since a flourishing
private pension system is the best guarantee of the PBGC's long-term
viability. In other words, as required under ERISA, PBGC must set
policies and act to encourage the establishment and continuation of
voluntary defined benefit plans. Plan funding and premium policies
should not force employers out of the voluntary pension system
prematurely and unnecessarily during periods of financial distress or
normal economic downturns.
Funding Objectives: In order to ensure that employees will receive
pension benefits from employer-sponsored plans, the primary objectives
of funding standards must be to foster plan continuation through
actuarially sound funding and to allow plan sponsors to anticipate
systematic and stable funding over time.
* Required contributions must be both predictable and stable in
order to facilitate capital planning in the sponsoring business.
* Funding standards should permit the pre-payment of contributions
when sponsors are able to do so.
* Funding standards must allow and facilitate diversification of
investments of pension plan assets, including investments in equities,
in order to ensure the growth and security of the plan.
* Funding standards must recognize the on-going and long-term
nature of pension plans; the primary focus of funding requirements
should be based on long-term measures and long-term assumptions.
* Short-term measures of a plan's funded status should be
monitored and taken into account in funding and disclosure decisions,
but also must balance funding goals with the need to avoid forcing plan
sponsors to choose between funding their plans and maintaining the
viability of their businesses.
Financial Disclosure to Participants: More meaningful and more
current disclosure is needed. Summary annual reports are not
meaningful. Investors receive better and more current information than
do plan participants.
* Plans should be required to provide participants early each year
with a statement of the plan's funded status based on timely
information currently available--such as information on plans compiled
for SFAS 87 disclosures.
* The new report should replace the summary annual report.
* As under current law, plans may provide participants with
additional information.
Underfunded Plans: To prevent the occurrence of benefit accruals
that are not likely to be funded within a reasonable period of time and
to reduce the PBGC's exposure to such benefit accruals, special
restrictions on benefit increases and payouts should be imposed on
plans that are severely underfunded and likely to terminate. This will
limit cost shifting from failed plans to ongoing plans through
increased PBGC premiums.
* Restrictions should be imposed on a graded scale--the most
severe restrictions reserved for the most underfunded plans.
* Restrictions imposed on benefit accruals or lump sum
distributions must be workable and as minimally disruptive of business
operations, workforce management goals, and participants' needs as
possible, and not invite or lead to lawsuits against employers.
Conclusion
To secure defined benefit pension plans and lay the groundwork for
their expansion in the future, Congress must take action now to:
* adopt the long-term corporate bond rate as a permanent interest
rate for calculating liabilities, and
* provide legal certainty for hybrid plans.
However, before enacting pension funding reforms, Congress must
ensure that reforms result in rules that support predictable and stable
plan funding.
The Administration has stated that it wants to ensure that plans
are funded so employees will be assured of receiving their benefits. We
agree. But aspects of the specific proposal put forward are so harsh,
volatile and unpredictable that many plan sponsors will be forced to
freeze their plans, and in some cases may be forced into bankruptcy.
Moreover additional workers will not have the opportunity to earn
pension benefits because their employer will not consider installing a
defined benefit plan under such a structure.
The Administration also has stated it wants to avoid a taxpayer
bailout of the PBGC. We agree. But the best assurance of a sound PBGC
is a robust defined benefit system. We do not believe that the
Administration's proposal accomplishes this goal and in fact may put
the PBGC in a worsening position.
We appreciate the opportunity to present our views and look forward
to working with the Committee and the Administration to provide
opportunities for American workers to attain lasting retirement
security.
[An attachment to the ERISA Industry Committee's statement
follows:]
[GRAPHIC] [TIFF OMITTED] T9772.018
[GRAPHIC] [TIFF OMITTED] T9772.019
______
Statement of the American Society of Pension Professionals & Actuaries,
Submitted for the Record
The American Society of Pension Professionals & Actuaries (ASPPA)
appreciates the opportunity to submit our comments to the House
Committee on Education and the Workforce on several important elements
of defined benefit reform. ASPPA is a national organization of almost
5,500 retirement plan professionals who provide consulting and
administrative services for qualified retirement plans covering
millions of American workers. ASPPA members are retirement
professionals of all disciplines, including consultants,
administrators, actuaries, accountants, and attorneys. Our large and
broad based membership gives it unusual insight into current practical
problems with ERISA and qualified retirement plans, with a particular
focus on the issues faced by small to medium-sized employers. ASPPA's
membership is diverse, but united by a common dedication to the private
retirement plan system.
ASPPA applauds the Committee's leadership in exploring defined
benefit funding reform. The Committee on Education and the Workforce's
consistent focus on pension issues over the years has advanced
improvements in the employer-sponsored pension system, as well as led
to an increased awareness of the need to focus attention on the
retirement security of our nation's workers. ASPPA looks forward to
working with Congress and the Administration on strengthening the
defined benefit system.
Maximum Deductible Contribution Limit
The Administration has stated that their defined benefit reform
proposal is intended to strengthen workers' retirement security by
ensuring that defined benefit plans are adequately funded. To this end,
they have proposed a maximum deduction amount using a combination of a
plan's new ongoing liability funding target and a 30 percent cushion of
such new funding target. ASPPA believes that this new maximum deduction
limit does not adequately address the needs of small to medium-sized
companies.
For a healthy plan sponsor, the Administration's new maximum
deductible contribution would be equal to the present value of all
accrued benefits, (assuming a salary increase factor and computed using
the proposed yield curve), plus a 30 percent cushion of this amount.
The Administration has stated that their suggested reforms to the
current defined benefit funding rules, including the maximum deduction
rules, ensure adequate funding and would provide greater flexibility
for employers to make additional contributions in good economic times.
After close analysis of the Administration's proposed maximum
deductible contribution limit, in conjunction with the allowable
actuarial assumptions for such a calculation, ASPPA has discovered that
in certain circumstances involving small to medium-sized companies, the
Administration's proposed maximum deductible contribution limit would
actually be decreased, rather than increased, as compared to current
law. This would preclude small to medium- sized employers from funding
their plans sufficiently as they can under current law. Thus, rather
than strengthening the funding rules, the proposed reform would, in
some cases, actually weaken them.
Consider the following example: A defined benefit plan has been
established with 21 participants (6 highly-compensated and 15 non-
highly compensated), with a defined benefit formula based on 4 percent
of average pay for each year of participation up to a maximum of 25
years. Under current law, and based on allowable actuarial assumptions,
the maximum deductible contribution that could be made to this defined
benefit plan would be $382,914. The maximum deductible contribution
allowable under the Administration's formula, based on a yield curve
and allowable actuarial assumptions, would be $273,048. This amounts to
a funding difference of $109,866, which is certainly significant for a
small business. Although this funding difference occurs when a plan is
first established, it is important to keep in mind that this funding
deficiency will have to be made up later, when the small business may
not be in a financially-sound position to do so.
The reason for this discrepancy in the maximum deductible
contribution is based on the fact that the Administration's proposal,
although allowing for an assumption for salary increases for workers,
does not allow the plan to assume salary increases for many small
business owners. This is because the Administration's proposal does not
permit the plan to assume the statutorily provided inflation increases
in the compensation limit for determining benefits [IRC section
401(a)(17)].\1\ As a consequence, some plans will not be able to fund
for these small business owner benefits, even though the law allows
such benefits to be accrued. The resulting funding mismatch is a
particular problem for successful small businesses. While some plans
would be able to take advantage of the 30 percent cushion provided
under the Administration's proposal, many others, such as the small
business in this example, would not.
---------------------------------------------------------------------------
\1\ The annual compensation limit under the ``401(a)(17)'' limit
cannot generally exceed $200,000, to be adjusted for cost-of-living
increases beginning in 2002. The current 401(a)(17) limit for 2005 is
$210,000.
---------------------------------------------------------------------------
For many small and medium-sized companies, not being allowed to
assume the statutorily provided inflation increases in the IRC section
401(a)(17) compensation limit will create an inappropriate funding
deficiency when a plan is first established. Thus, since the
Administration's current proposal effectively discriminates against the
benefits of many small business owners, the plan will potentially have
a funding shortfall just as it starts. Significantly, under the above
example, if the statutorily provided inflation increases in the IRC
section 401(a)(17) compensation limit were allowed to be assumed, the
maximum deductible contribution limit under the Administration's
proposal would increase to $363,313, a contribution limit similar to
current law.
Based upon these results, ASPPA recommends that the Administration
funding proposal be modified to permit the statutorily provided
inflation increases in the IRC section 401(a)(17) compensation limit to
be assumed for purposes of calculating the maximum deductible
contribution limit in order to assure funding adequacy for all plans,
including small businesses. As we have shown, the Administration's
proposal would unfairly discriminate against successful small
businesses and hinder the creation of new defined benefit plans.
Concurrently, ASPPA supports an increase in the deduction limit of a
plan's ongoing liability funding target from the proposed 130 percent
to 150 percent of such target. By increasing this cushion, employers
would be provided with more flexibility in determining their pension
contributions, particularly in good economic times. Being able to make
additional pension contributions in good times would also be consistent
with the Administration's proposal that defined benefit plans be
adequately funded.
Disclosure under Schedule B of the Form 5500
A main concern of the Administration is that the asset and
liability information provided under the current Schedule B of the Form
5500 annual report/return does not adequately provide an accurate and
meaningful measure of a plan's funding status. Under the
Administration's proposal, all single-employer defined benefit plans
covered under the Pension Benefit Guaranty Corporation (PBGC) with more
than 100 participants, and required to make quarterly contributions for
the plan year, would be required to file a Schedule B with their Form
5500 by the fifteenth day of the second month following the close of
the plan year (if calendar year, February 15). Where a contribution is
subsequently made for the plan year, an amended Schedule B would be
required to be filed under the Form 5500's existing requirements.\2\
Under the Administration's proposal, these plans would be required to
use a beginning of plan year valuation.\3\
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\2\ Under current law, defined benefit plans subject to minimum
funding standards are required to file a Schedule B with the Form 5500,
which is generally due seven months after the end of the plan year (if
calendar year, July 31), with a two and a half month extension
available (if calendar year, October 15).
\3\ Under current law, defined benefit plans are allowed to use any
valuation date of a plan year for disclosure purposes.
---------------------------------------------------------------------------
ASPPA recognizes that while some accelerated information would be
helpful to provide an early warning system to protect the PBGC, an
expanded exemption from the new Schedule B filing requirement should be
made for small to medium-sized plans, similar to the Administration's
exemption for plans subject to the at-risk liability calculation based
on a plan sponsor's financial health. An earlier reporting requirement
for many small to medium-sized plans that do not pose a potential risk
to the PBGC would unnecessarily increase administrative complexity and
costs. In addition, requiring an earlier valuation date for certain
small to medium-sized plans not subject to Administration's accelerated
filing date would further expand an unnecessary administrative burden
on these plans.
ASPPA recommends that only plans with 500 or more participants that
are required to make quarterly contributions be required to file a
report on the funded status of the plan within 90 (ninety) days after
the close of the plan year (if calendar year, March 31). This reporting
would be done using a newly-created form Schedule B-1 (which would be
filed electronically, if possible) and would provide only the asset and
liability information necessary to disclose the plan's funded status as
of the valuation date in the prior plan year (retaining the current law
structure of allowing any plan valuation date in a plan year.) Any
additional reporting information, such as the annual contribution
information, should continue to be reported on the regular Schedule B
filed with the Form 5500. In addition, we recommend that plans not
subject to the Administration's accelerated filing date with less than
500 participants be allowed to retain the current law structure of
allowing any valuation date.
Consistent with the interests of the Administration, this new
Schedule B-1 would allow the dissemination of more accurate and timely
information regarding the funded status of a plan, without causing a
substantial administrative or financial hardship on small to medium-
sized plans that pose little potential risk to the PBGC.
The Impact of Fluctuating Interest Rates on Lump Sum Calculation
As sponsors of defined benefit plans promise a guaranteed benefit
to their participants, a plan sponsor must calculate on a year-by-year
basis the extent to which contributions are required to fund those
promised benefits. Under current law, when a benefit will be paid in
the form of a lump sum a common occurrence for defined benefit plans--
the calculation of the annual contribution requirements consists of
several elements. First is the requirement that a promised benefit not
exceed a specified amount (the ``415 limit'') \4\, which is expressed
in terms of a life annuity. Second, if a participant in a defined
benefit plan elects benefit payment in a form other than a life annuity
(e.g., lump sum, term certain), the 415 limit must be converted to
reflect this alternative form of benefit.
---------------------------------------------------------------------------
\4\ The annual benefit limit under IRC 415 (the ``415 limit'') is
the lesser of (1) 100 percent of the participant's average compensation
over the highest three consecutive years, or (2) $160,000 (indexed for
inflation), expressed in terms of a life annuity beginning at age 65.
---------------------------------------------------------------------------
Prior to 1995, the interest rate assumption generally used when
making this conversion was 5 percent. Thus, for example, the 415 limit
for a lump sum distribution could be determined mathematically in
advance of the participant's retirement. This permitted an employer to
know exactly, upon performance of a relatively simple calculation, what
its annual plan contribution obligations would be. This was
particularly crucial for smaller defined benefit plans, since the
payout to even one single participant can have a dramatic impact on
overall plan funding, and thus on annual contribution obligations.
From 1995 to 2003, the 415 limit for forms of benefit other than a
life annuity was determined by using the 30-year Treasury bond rate,
which produced a fluctuating month-to-month interest rate. The Pension
Funding Equity Act of 2004 (PFEA ``04) amended IRC 415 to provide that
for plan years beginning in 2004 or 2005, an interest rate assumption
of 5.5 percent was to be used in lieu of the applicable interest rate.
This temporary interest rate assumption was a welcome relief to smaller
defined benefit plans, as it provided much needed simplicity and
predictability in making lump sum calculations.
The Administration's proposal, while not expressly addressing the
415 issue, does not appear to extend this 5.5 percent interest rate
assumption in determining the 415 limit for lump sum calculations.
Instead, the proposal seems to contemplate that the contribution amount
to fund a lump sum payment subject to the 415 limit be calculated by
using interest rates drawn from a zero-coupon corporate yield curve.
The complexity of the yield curve calculation would create a
significant volatility problem facing small and medium-sized defined
benefit plan sponsors. Using the yield curve to determine funding
obligations for the 415 limit based on monthly fluctuating interest
rates would make it very difficult for smaller businesses to properly
fund their plans and virtually impossible to project funding
obligations into future years. It would create confusion to plan
sponsors and plan participants whose lump sum payment amounts may
bounce up and down as these rates change. It would also cause plans to
be unable to reasonably determine their liabilities with regard to
benefits payable in a lump sum and other forms of payment.
Affordability issues are also raised a plan sponsor will
justifiably wonder whether it will be able to afford to guarantee the
defined benefit. There would be a chilling effect on a plan sponsor's
willingness to establish a plan because of the impossibility of
predictability for the plan's obligations. The problems arising from
being wholly dependent on the whims of a widely-fluctuating interest
rate would be a major deterrent to the establishment of defined benefit
plans, especially for small businesses.
In order to provide for a more predictable funding requirement for
small defined benefit plans, ASPPA recommends that the use of the
current 5.5 percent interest rate assumption for benefit forms other
than a life annuity (i.e., lump sums) for purposes of the 415 limits as
set forth in PFEA ``04 be made permanent. This use of a flat interest
rate would remove the volatility from the determination of lump sums
and other form of benefits, ensure consistency for planning purposes,
pave the way for the potential establishment of new defined benefit
plans by small businesses, and be no more generous than current law.
Reduced PBGC Premiums for Small and New Plans
Finally, while ASPPA agrees that some reform of the PBGC premium
structure is necessary to increase the PBGC revenue needed to meet
expected claims and improve their underlying financial condition, an
exception from the Administration's proposed fixed and risk-based
premium (which would replace the current Variable Rate Premium) should
be created for small and new defined benefit plans that pose no
significant risk to the PBGC. These plans expose the PBGC to little, if
any, liability, and accordingly should be charged minimal premiums.
The Administration's defined benefit reform proposal would increase
the current fixed rate to reflect the cost of living adjustment (COLA)
from 1991, and index the fixed premium thereafter. The Administration
would also assess a new risk-related premium on all plans with assets
less than their funding target. While the premium rate per dollar of
underfunding would be identical for all plans, the Administration has,
however, suggested an unorthodox system that would allow this premium
rate per dollar of underfunding to be set, reviewed, and revised
periodically by the PBGC Board. The Administration represents that
these premium increases are necessary to mitigate future losses and
retire PBGC's deficit (currently valued at $23 billion) over a
reasonable time period.
This new premium structure would create a great deal of uncertainty
for plan sponsors every year in budgeting for PBGC premiums. Further,
with unprecedented authority being provided to the PBGC Board to set
the risk-related premium, there is a potential that these premiums
could unnecessarily escalate for certain plan sponsors who do not pose
a significant risk to the PBGC, under the pretext of decreasing the
PBGC deficit. It would not only force many plan sponsors, especially
small to medium-sized companies, to exit the system, it would also
restrict the creation of new plans and future PBGC premium-payers.
ASPPA recommends that an exception be provided to small and new
plans from these proposed PBGC premium reforms. These two non-
controversial exceptions have been introduced by Congressional
lawmakers in prior legislation. Most recently, they were included in
the Senate Finance Committee's reintroduced pension protection
legislation, the National Employee Savings and Trust Equity Guarantee
(NESTEG) Act, introduced by Committee Chairman Charles Grassley (R-IA)
and ranking member Max Baucus (D-MT) on January 31, 2005. They were
also included in the House pension reform bill, the Pension Security
Act of 2004 (H.R. 1000), introduced in the 108th Congress by House
Committee on Education and the Workforce Chairman John Boehner (R-OH)
and passed by the House on May 14, 2003.
ASPPA proposes for new small plans \5\ (maintained by controlled
group with 100 or fewer employees), that the premium for each of the
first five years of existence be set at $5 per participant with no
risk-related premium owed. For new plans that have over 100
participants, the PBGC premium should be phased in at a variable rate
over the first five years (20 percent for first year, 40 percent for
second year, and so on).
---------------------------------------------------------------------------
\5\ A new plan means a defined benefit plan maintained by a
contributing sponsor if, during the 36-month period ending on the date
of adoption of the plan, such contributing sponsor (or controlled group
member or a predecessor of either) has not established or maintained a
plan subject to PBGC coverage with respect to which benefits were
accrued for substantially the same employees as in the new plan.
---------------------------------------------------------------------------
Further, for very small plans (maintained by controlled groups with
25 or less employees), ASPPA proposes to either: (1) cap their variable
rate premium payments for each participant to an amount equal to $5
times the number of plan participants; or (2) allow the exclusion of
substantial owner benefits in excess of the phased-in amount from their
variable rate premium calculations.
Conclusion
ASPPA appreciates the opportunity to offer its perspective on these
very important defined benefit reform issues. We believe any new
reforms should be designed to stimulate and protect the defined benefit
system. ASPPA looks forward to working with the Committee and the
Administration on a comprehensive solution to defined benefit reform.
______
Letter from the Food Marketing Institute, Submitted for the Record
March 2, 2005
The Honorable John Boehner, Chairman
Committee on Education and the Workforce
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Boehner:
The Food Marketing Institute (FMI), on behalf of the nation's
neighborhood grocery stores, respectfully submits this letter for your
hearing record. FMI represents supermarkets and food wholesalers
employing 3.5 million associates.
We agree that it is an important time to reform the defined benefit
pension system. We respectfully request that your Committee's review
cover defined benefit multiemployer plans, as well as single employer
plans. The former play an important role in providing retirement
benefits for almost 10 million American workers and the laws governing
their sound operation need to be revised and updated. We look forward
to working with you and your Committee to resolve the fiscal crisis
currently facing all defined benefit plans.
Sincerely,
John J. Motley III
Senior Vice President
Government and Public Affairs
______
Statement of Alan Reuther, Legislative Director, International Union,
United Automobile, Aerospace & Agricultural Implement Workers of
America (UAW), Submitted for the Record
Introduction
This testimony is submitted on behalf of the International Union,
United Automobile, Aerospace & Agricultural Implement Workers of
America, (UAW), in connection with the hearing scheduled for March 2,
2005 by the Committee on Education and the Workforce on the subject of
The Retirement Security Crisis: The Administration's Proposal for
Pension Reform and its Implications for Workers and Taxpayers.
The UAW represents 1,150,000 active and retired employees in the
automobile, aerospace, agricultural implement and other industries.
Most of our active and retired members are covered under negotiated
single employer defined benefit pension plans (hereafter referred to as
``pension plans'').
The UAW has a long and proud history of involvement in legislation
relating to these pension plans. We were in the forefront of the decade
long struggle to enact ERISA, which led to the establishment of the
PBGC. We also were actively involved in the enactment of legislation in
1987 and again in 1994 to strengthen the funding of pension plans and
the PBGC.
The UAW believes Congress once again needs to adopt balanced
proposals that will strengthen the funding of pension plans and
encourage employers to continue these plans. We also support new
measures to bolster the PBGC and the security of pension benefits for
workers and retirees.
Unfortunately, the package of proposals advanced by the
Administration will not achieve these objectives. In our judgment, the
Administration's pension proposals are dangerous and counterproductive.
They would punish employers who are already experiencing financial
difficulties, resulting in more pension plan terminations and loss of
retirement benefits, more bankruptcies, plants closings and layoffs,
more liabilities being dumped on the PBGC, and more employers choosing
to exit the defined benefit pension system. As a result, these
proposals would be bad for employers, bad for workers and retirees, bad
for the PBGC and bad for the entire defined benefit pension system.
The UAW urges the Committee on Education and the Workforce to
reject the Administration's proposals, and instead to put forward a
bipartisan package of proposals that will improve the funding of
pension plans and bolster the PBGC, without punishing employers,
workers and retirees. We stand prepared to work with the Committee to
achieve these objectives.
I. Strengthening the Funding of Pension Plans
The UAW supports balanced legislation to strengthen the funding of
pension plans. These reforms should be designed to ensure that benefits
promised by employers to workers and retirees are adequately funded,
thereby improving the security of these benefits and also reducing the
PBGC's exposure for unfunded pension liabilities.
However, the UAW believes it is imperative that any new funding
rules should be structured so as to provide predictable, stable funding
obligations for employers and to reduce the volatility of required
contributions from year to year. New funding rules should also
encourage employers to contribute more than the bare minimum in good
times, and avoid counter-cyclical requirements that punish employers
during economic downturns.
Unfortunately, the funding proposals advanced by the Administration
fail to meet these common sense objectives. The UAW strongly opposes
the Administration's funding proposals because they would result in
highly volatile pension funding obligations, would reduce incentives
for employers to contribute more than the bare minimum, and would
punish employers who are already experiencing economic difficulties.
A). Interest Rate Assumption
The UAW strongly opposes the Administration's proposal to require
employers to use a so-called yield curve in establishing the interest
rate assumption for pension plans. Under this proposal, the interest
rate would be based on a near-spot rate (averaged over only 90 days),
with a different interest rate being applied to each payment expected
to be made by the plan based on the date on which that payment will be
made.
This proposal has a number of fundamental problems. First, it would
be extremely complicated, imposing considerable administrative burdens
on plan sponsors. These burdens may discourage employers from
continuing defined benefit pension plans (especially small- and mid-
sized companies).
Second, contrary to the Administration's assertions, the yield
curve would not provide greater ``accuracy'' in setting the interest
rate assumption. Because there is no real market for corporate bonds of
many durations, these interest rates would largely be fictitious.
Third, the yield curve would result in highly volatile funding
requirements that would fluctuate widely as interest rates change over
time. This increased volatility would create enormous difficulties for
employers, who need stability and predictability in their funding
obligations. Indeed, the increased volatility would be a powerful
incentive for employers to exit the defined benefit system.
Fourth, the yield curve would impose higher funding obligations on
older manufacturing companies that have larger numbers of retirees and
older workers. As a result, it would exacerbate the competitive
disadvantage that many of the companies currently have because of heavy
legacy costs, and would punish companies that are already experiencing
economic difficulties.
Instead of this dangerous and counterproductive yield curve
proposal, the UAW urges the Committee on Education and the Workforce to
make permanent the long term corporate bond interest rate assumption
that was included in the temporary legislation enacted by Congress last
year. In our judgment, this long term corporate bond interest rate
assumption would provide an economically sound and accurate basis for
valuing pension liabilities, would be administratively simple for plan
sponsors to implement, would result in stable and predictable funding
obligations for employers, and would avoid imposing unfair, counter-
cyclical funding burdens on older manufacturing companies.
At the same time, the UAW urges the Committee on Education and the
Workforce to allow employers to use collar-adjusted mortality tables in
valuing their plan liabilities. This would enable employers to more
accurately value the future benefit obligations, especially for older
manufacturing companies with larger numbers of retirees and older
workers.
B). Improving Plan Funding
The UAW strongly opposes the Administration's proposal to throw out
the existing funding rules in their entirety, and to replace them with
new funding rules based on spot valuations of assets and liabilities,
with no smoothing mechanisms, and with funding targets tied to a
company's credit rating. These changes would introduce an enormous
element of volatility into pension funding requirements. This would
make it much more difficult for companies to plan their cash flow and
liability projections, and thus would provide yet another powerful
incentive for employers to exit the defined benefit pension system. In
addition, these changes would punish companies that are already
experiencing economic difficulties and have poor credit ratings by
imposing sharply higher funding obligations on these employers. The net
result could be more bankruptcies, job loss and plan terminations, with
even more unfunded liabilities being transferred to the PBGC.
Instead of this counterproductive approach, the UAW urges the
Committee on Education and the Workforce to support changes in the
existing deficit reduction contribution (DRC) rules that would lead to
improved funding of pension plans, but also provide smoother, more
predictable funding obligations for employers and less onerous,
counter-cyclical burdens on employers experiencing a temporary
downturn. We believe this could be accomplished through two changes:
(1) modifying the trigger for the DRC so that it applies to a broader
universe of plans, and also is triggered more quickly when a plan
becomes less than fully funded; and (2) reducing the percentage of the
funding shortfall that must be made up in any year, so there will be a
smoother path towards full funding. These changes would help to ensure
that more employers are required to make up funding shortfalls in their
plans, and are required to begin taking this action sooner. At the same
time, these changes would avoid wild swings in a company's funding
obligations that can have negative, counter-cyclical effects,
especially on employers who are already experiencing economic
difficulties.
The UAW also urges the Committee on Education and the Workforce to
adopt changes to the general ERISA funding rules to shorten the
amortization period for plan amendments from 30 to 15 years. This would
bring this amortization period more in line with the average remaining
working life of most participants. It would require more rapid funding
of benefit improvements, and thereby help to improve the overall
funding of pension plans.
Finally, the UAW supports modifying the definition of ``current
liability'' to take into account lump-sum distributions reasonably
projected to be taken by plan participants. This would require plans to
provide adequate funding to cover anticipated lump sum distributions,
and help to prevent situations where plans have been drained because of
such distributions.
C). Credit Balances
The UAW strongly opposes the Administration's proposal to
completely eliminate credit balances, which are currently created when
an employer contributes more than the minimum required under existing
funding rules. By eliminating credit balances entirely, the
Administration's proposal would have the perverse effect of
discouraging companies from contributing more than the bare minimum
during good economic times. This, in turn, could make the funded status
of pension plans even worse.
Instead of this counterproductive approach, the UAW urges the
Committee on Education and the Workforce to modify the existing rules
regarding credit balances on a prospective basis, so that employers are
required to value new credit balances according to the actual market
performance of the extra amounts contributed by the employer. This
would eliminate problems that have arisen when the actual market
performance diverges from plan assumptions. But it would still preserve
the important incentive that credit balances provide for employers to
contribute more than the minimum required under the funding rules.
The UAW also supports increasing the deduction limit from 100
percent to 130 percent of current liability. This would allow employers
to contribute more during good economic times, and to build up a bigger
cushion to help during economic downturns.
In addition, the UAW supports modifying the current rules on the
use of excess pension assets, so that employers are allowed to use
these assets for health care expenditures for active and retired
employees, not just for retirees. This would provide yet another
incentive for employers to better fund their pension plans during good
economic times, by providing greater assurance that companies can
always benefit economically from surplus pension assets.
D). Limits on Benefits
The UAW strongly opposes the Administration's proposals to place
strict, arbitrary limits on benefits provided by pension plans that are
less than 100 percent funded. These proposals would have a sharply
negative impact on workers and retirees. In effect, they would reduce
the adequacy of retirement benefits provided by pension plans to tens
of thousands of workers and retirees. We are particularly troubled by
the Administration's proposals to freeze benefit accruals, which would
have an especially devastating impact on workers and their families.
The UAW is also outraged by the Administration's radical proposal
to prohibit pension plans from even offering plant-closing benefits.
These types of benefits have been an important means of cushioning the
economic impact of plant closings as companies struggle to reorganize.
By making it possible for more workers to retire with an adequate
income, these benefits reduce the number of workers who have to be laid
off and wind up drawing unemployment insurance and retraining benefits.
It makes no sense, therefore, to prohibit plans from even offering this
type of benefit.
The UAW also is concerned about the discriminatory impact of the
Administration's proposals on blue-collar workers and retirees covered
under so-called flat dollar plans. It is patently unfair to place
restrictions on benefit improvements in flat dollar plans where the
parties simply attempt to adjust benefits in accordance with the growth
in wages, but to allow the benefit improvements that occur
automatically in salary related plans for white collar and management
personnel. In our judgment, any proposals should treat both types of
plans in an even-handed manner.
Contrary to the impression created by the Administration, current
law does not allow employers and unions to ``conspire'' to increase
benefits without regard to the funded status of a pension plan, and to
then terminate the plan and dump these unfunded benefit promises onto
the PBGC. By virtue of the five-year phase in rule, the PBGC may not
fully guarantee all benefit improvements preceding a plan termination.
Thus, so-called ``death bed'' benefit increases are not guaranteed and
do not result in any increase in the PBGC's liabilities.
The UAW does recognize that pension plans that are less than fully
funded have experienced problems with the payment of lump sum
distributions. In some cases, the payment of lump sums has drained
assets from these plans, unnecessarily jeopardizing the continuation of
the plans and the payment of benefits to other participants and
beneficiaries. Thus, the UAW would support reasonable limitations on
the payment of lump sums in such plans.
In addition, the UAW supports the enactment of a new ``plan
reorganization'' process for underfunded plans in situations where the
employer has filed for Chapter 11 bankruptcy reorganization. We believe
that this type of process could provide better flexibility in the
adjustment of benefits and funding obligations, and thereby enable more
companies in financial distress to continue their pension plans. This
would be beneficial for the participants and beneficiaries because it
would allow them to still have their pension plan and to keep some
benefits that would otherwise be lost in the event of a plan
termination. At the same time, this would be beneficial for the PBGC
because it would require the employer to continue making some
contributions to the plan and prevent the unfunded liabilities from
being transferred to the PBGC. Employers would also benefit from this
plan reorganization option because it would provide greater flexibility
in adjusting benefits and funding obligations, so that continuation of
the pension plan becomes manageable.
To make sure that this plan reorganization process is not abused,
the UAW believes it should only be available to employers that have
already taken the difficult step of filing for Chapter 11 bankruptcy
reorganization. Furthermore, the bankruptcy court should be empowered
to approve benefit and funding modifications beyond those already
permitted under current law only if they are approved by all of the
stakeholders: that is, by the PBGC, the employer, and union (or, in the
case of non-represented participants, an independent fiduciary
appointed by the bankruptcy court). Finally, the permissible benefit
modifications should be restricted to non-guaranteed benefits that
would be lost anyway in the event of a plan termination. Permissible
funding modifications should extend to thirty-year amortization of
existing unfunded liabilities.
The UAW believes that this type of plan reorganization process
could be a powerful tool for enabling struggling employers to continue
their pension plans, while protecting workers and retirees to the
maximum extent feasible, and also reducing the exposure of the PBGC.
This process could provide the flexibility that is needed to address
different economic situations that are presented in Chapter 11 cases,
rather than the one-size fits all approach proposed by the
Administration.
E). Cash Balance Plans
The UAW believes that traditional defined benefit pension plans are
better for workers and retirees than cash balance plans. At the same
time, we recognize that cash balance plans are better than defined
contribution plans or no pension plan at all. In recent years, the UAW
has negotiated cash balance plans to cover new employees at Delphi,
Visteon and other auto parts companies. This recognizes the difficult
economic situations facing domestic producers in this industry.
Unfortunately, the continuing legal uncertainty concerning cash
balance plans is causing some employers to shift to defined
contribution plans or not to offer any pension plan at all. This was
vividly demonstrated by the recent announcement by IBM that it would
only provide a defined contribution plan for future employees. This
trend is disturbing, both because it is bad for the future retirement
income security of workers and retirees, and because it could further
undermine the premium base for the PBGC.
For these reasons, the UAW supports legislation to resolve the
legal uncertainties surrounding cash balance plans, by making it clear
that they are not per se a violation of age discrimination laws. We
also support allowing greater flexibility for cash balance plans in
setting interest credits. At the same time, in situations where a
traditional defined benefit plan is converted to a cash balance plan,
we believe reasonable transition relief should be provided to older
workers who are near retirement. This combination of reforms would
protect the legitimate retirement expectations of older workers, while
at the same time allowing employers to remain in the defined benefit
pension system (and continuing paying premiums to the PBGC) through the
vehicle of cash balance plans.
II. Pension Benefit Guaranty Corporation (PBGC)
It is important, at the outset, to underscore that there is no
``crisis'' at the PBGC. As the Administration has admitted, the PBGC
has sufficient assets to pay all guaranteed benefits for many years to
come (at least until 2020, and possibly longer). Thus, the reports
about the PBGC's growing deficit should not create a stampede towards
extreme, counterproductive proposals. Congress should approach this
issue in a deliberative manner, and make sure that any remedies do not
cause more harm to workers, retirees, employers and the defined benefit
pension system.
There is no mystery about what has caused the PBGC to have a
growing deficit. In the recent past the PBGC was projecting a
significant surplus. But bankruptcies in the steel industry led to the
terminations of a number of pension plans with the largest unfunded
liabilities ever assumed by the PBGC. Now, bankruptcies in the airlines
industry are threatening to result in plan terminations with even
bigger unfunded liabilities. Thus, there is no dispute that the PBGC's
deficit is directly attributable to the widespread economic
difficulties and bankruptcies in the steel and airline industries.
Unfortunately, the Administration has come forward with three
dangerous and counterproductive proposals to address the PBGC's
projected deficit. In our judgment, these proposals would unfairly
punish workers and retirees. They would also punish employers who are
already experiencing economic difficulties, leading to more
bankruptcies and job loss, as well as more plan terminations. Moreover,
these proposals would encourage employers to exit the defined benefit
system, increasing the danger of even bigger pension liabilities being
transferred to the PBGC.
A). Premium Increases
The UAW opposes the Administration's proposal to drastically
increase the flat premium paid by all sponsors of single employer
defined benefit pension plans from $19 to $30, and to index the premium
for future increases in wages. We also oppose the Administration's
proposal to impose a huge increase in the variable rate premium charged
to employers that sponsor plans that are less than fully funded, and to
have the amount of this variable rate premium vary depending on the
credit rating of a company.
First, the magnitude of these premium increases would impose
significant economic burdens on many companies. This would be
especially hard on companies that are already experiencing economic
difficulties and on medium-sized and small businesses. It would also
exacerbate the competitive disadvantage for many older manufacturing
companies with large legacy costs.
Second, the change in the structure of the variable rate premium-
specifically, linking it to a company's credit rating-would have the
perverse affect of punishing companies that are already in difficult
economic situations. Again, this would exacerbate the competitive
disadvantage facing many older manufacturing companies.
In light of these factors, the UAW believes the Administration's
premium proposals would be counterproductive. At a minimum, these
proposals would encourage an exodus of employers from the defined
benefit pension system. This could undermine the retirement income
security of millions of workers and retirees. It would also narrow the
premium base for the PBGC, and thereby increase its financial
difficulties. In the end, there is a real danger that the PBGC and the
defined benefit pension system could enter into a death spiral, with a
constantly shrinking premium base and growth in the pension liabilities
being transferred to the PBGC.
B). PBGC Guarantees
The UAW opposes the Administration's proposals to cut the PBGC
guarantees. These include freezing the guarantees when an employer
files for Chapter 11 bankruptcy, and effectively eliminating any
guarantee for plant closing benefits. These changes would unfairly
punish tens of thousands of workers and retirees, reducing their
retirement benefits and leaving them with a sharply reduced standard of
living.
It is important to emphasize that, under current law, workers and
retirees often lose a portion of their benefits when a plan is
terminated. Because of the five-year phase in rule and other limits,
workers and retirees typically lose a portion of their benefits
attributable to recent benefit improvements and certain early
retirement benefits. The UAW believes that these benefit losses should
not be made worse by further reductions in the scope of the PBGC
guarantees.
C). PBGC Lien for Unpaid Contributions
The UAW opposes the Administration's proposal to give the PBGC a
lien in bankruptcy proceedings for any unpaid pension contributions.
This would punish troubled companies and their retirees, and lead to
more liquidations, lost jobs and lost retiree health benefits. It could
also result in more plan terminations and even greater pension
liabilities being transferred to the PBGC.
Companies do not lightly take the step of filing for Chapter 11
bankruptcy. They do so only when they are experiencing significant
economic difficulties and are unable to pay all debts when due. Chapter
11 bankruptcy, by definition, is a zero sum situation. To the extent
one creditor is given a higher priority or greater claim on the
company's assets, this necessarily means that the other creditors will
receive less.
Thus, granting the PBGC a lien against a company's assets for any
unpaid pension contributions necessarily means that other creditors-
lending institutions, suppliers and other vendors, and the workers and
retirees-would recover less. This would inevitably trigger a number of
counterproductive, harmful consequences.
First, lenders would be more reluctant to provide the financing
that is critically important to ensuring the successful reorganization
of companies in Chapter 11 proceedings. Without this financing, there
would be more liquidations and hence more job loss. Even worse, the
negative ramifications on the lending community would extend to
companies that have not yet filed for Chapter 11 bankruptcy, but who
are experiencing economic difficulties and are potential candidates for
Chapter 11. To protect themselves, lenders would be forced to charge
higher costs to these troubled companies or even refuse financing. The
end result could be more bankruptcies, and even more job loss.
Second, retirees would be particularly hard hit by any PBGC lien
for unpaid pension contributions, since this would significantly reduce
their ability to collect on claims for retiree health insurance
benefits. In many of the Chapter 11 cases where there is an underfunded
pension plan, the single biggest group of unsecured creditors are the
retirees with their claim for health insurance benefits. If the PBGC is
given a lien for unpaid pension contributions, the practical result
would often be that there are no assets left to provide any retiree
health insurance benefits. Thus, the net result of increasing the
PBGC's recovery would be to punish the retirees--the very people the
PBGC was created to protect.
Third, other suppliers and vendors would also be negatively
impacted by the granting of a lien to the PBGC for unpaid pension
contributions. In many bankruptcies, this means that these other
businesses would get a significantly reduced recovery for their claims.
This could jeopardize their ability to continue in business, leading to
a chain reaction of more bankruptcies and job loss.
Fourth, it is highly questionable whether the PBGC would ultimately
benefit by being granted a lien for unpaid pension contributions. To
the extent this proposal forces more companies to liquidate more
quickly, there would be more plan terminations and even more pension
liabilities transferred to the PBGC.
The PBGC already has significant leverage in bankruptcy proceedings
because of the enormous claims it has for unfunded liabilities, and
because of its ability to affect the timing and other aspects of plan
terminations. There is simply no need to increase the PBGC's leverage,
to the detriment of workers, retirees, employers, and the entire
defined benefit pension system.
D). A Positive Approach to Strengthening the PGGC
Instead of the harmful, counterproductive proposals advanced by the
Administration, the UAW believes that the PBGC can be strengthened
through a number of approaches that would protect the interests of
workers and retirees, employers and the entire defined benefit pension
system.
First, the UAW believes that the overall funding of pension plans
can be strengthened through the reforms we have previously supported in
Section I of this testimony. By taking steps now to improve the funding
of pension plans, Congress can improve the security of benefits for
workers and retirees, and also reduce the long-term exposure of the
PBGC. These reforms can also encourage employers to continue defined
benefit pension plans, while avoiding counterproductive burdens on
employers who are experiencing economic difficulties.
Second, the UAW believes that the plan reorganization process
discussed previously in Section I of this testimony can be especially
helpful in reducing the number of bankruptcy cases that lead to pension
plan terminations and liabilities being transferred to the PBGC. In
particular, we believe this type of process could be important
immediately in providing the flexibility necessary for United and other
airlines to continue their pension plans, instead of terminating them.
This would significantly reduce the PBGC's deficit, by keeping these
airline pension liabilities from being transferred to the PBGC. It
would also benefit the workers and retirees at these airline companies,
by keeping their pension plans going and allowing them to receive
greater benefits than they would if the plans were terminated. At the
same time, this reorganization process could provide significant
economic relief to the troubled airlines, while still requiring them to
continue some level of pension contributions. The same combination of
factors could also make this type of reorganization process helpful in
other industries, thereby reducing the PBGC's future exposure for
pension liabilities.
Third, the UAW believes that the best way to deal with the steel
and airline pension liabilities that have already or will soon be
assumed by the PBGC is to have the federal government finance these
liabilities over a thirty year period. This could be accomplished by
having the federal government (or the PBGC) issue thirty-year bonds,
and then have the federal government pay the interest on these bonds as
it comes due. We believe this approach would cost the federal
government about $1-2 billion per year, depending on the magnitude of
the airline pension liabilities that are ultimately assumed by the
PBGC.
The UAW recognizes that the federal government is already running
substantial budget deficits. But this infusion of federal funds to
strengthen the PBGC can easily be afforded by our nation. For example,
in its current budget, the Administration has proposed significant
increases in the amounts that individuals can contribute to various
individual retirement and savings accounts (so-called RSAs and LSAs).
This involves a substantial tax expenditure that will flow
overwhelmingly to upper income individuals. The Congressional Research
Service has estimated that this proposal will cost the equivalent today
of $300 to $500 billion over ten years. The UAW submits that these
funds could better be used to strengthen the PBGC and protect the
retirement benefits of average working families in defined benefit
pension plans.
Whatever the difficulties, the fact remains that using general
revenues to gradually finance the PBGC's steel and airline related
pension deficit is better than all of the other options currently being
considered. Specifically, it is better than punishing workers and
retirees by cutting the PBGC guarantees. It is better than punishing
companies that sponsor pension plans by drastically increasing their
PBGC premiums. And it is better than punishing companies that are
experiencing financial distress by giving the PBGC a greater claim in
bankruptcy proceedings. These other options will inevitably hurt
workers and retirees and employers that sponsor pension plans. They
will also lead to more bankruptcies and job loss. And they will drive
employers away from the defined benefit pension system, creating a
death spiral for the PBGC.
The truth is the PBGC was never designed to handle widespread
bankruptcies and pension plan terminations across entire industries, as
we have seen in steel and are now witnessing in airlines. Indeed, the
seminal case that led to the creation of the PBGC was the Studebaker
situation, in which a single auto company went out of business and
terminated its pension plan. Obviously, the entire auto industry did
not go bankrupt or terminate its pension plans then.
When the PBGC was created by Congress, it was modeled after the
Federal Deposit Insurance Corporation (FDIC), which insures bank
deposits for individuals. The FDIC was designed to handle isolated bank
failures, not the collapse of a broad section of the banking industry.
When the savings and loan crisis occurred in the 1980s, Congress wisely
recognized that the costs associated with S & L failures should not be
shifted onto the backs of individual depositors, nor onto the backs of
other banking institutions. Congress recognized that those alternatives
would impose unacceptable hardships on individuals and other banks, and
would have a counterproductive impact on the rest of the banking system
and our entire economy. As a result, Congress decided to have the
federal government finance the S & L liabilities over many years, at a
cost of hundreds of billions of dollars.
The same principles make sense in the case of the steel and airline
pension liabilities that have or will be assumed by the PBGC. Shifting
those costs onto workers and retirees or employers that sponsor pension
plans would simply lead to unacceptable hardships and counterproductive
economic consequences. The best approach-for workers and retirees, for
employers that sponsor pension plans, for troubled companies and for
our entire economy-is to spread those costs gradually and broadly
across society by having the federal government finance them over
thirty years.
This approach would not reward ``bad actors''. The steel and
airline bankruptcies and pension plan terminations were caused by many
factors, including the policies (or non-policies) of the federal
government relating to trade, deregulation, energy and health care, as
well as the shocks flowing from the terrorist attacks on September
11th. In our judgment, it is entirely appropriate to now ask the
federal government to help pay for the pension costs flowing from those
policies and events.
Indeed, Congress already endorsed this notion in a more limited
context. In the Trade Act of 2002, Congress provided for a new 65
percent tax credit to pay for retiree health benefits for retirees
whose pension plans have been terminated and taken over by the PBGC,
and who are between the ages of 55-65. Through this provision, Congress
effectively used general revenues to pay for part of the costs
associated with providing retiree health benefits to this group of
retirees. This provision was designed primarily as a response to the
bankruptcies (and pension plan terminations) in the steel industry,
which had resulted in thousands of steelworker retirees losing their
health benefits. It reflected a recognition by Congress that our trade
and health care policies had played a role in the steel company
bankruptcies and the loss of retiree health benefits. The UAW submits
that the same principles now justify using general revenues to pay for
the pension costs flowing from the steel and airline bankruptcies and
plan terminations.
Similarly, Congress has a long history of using general revenues to
respond to disasters across our nation. This includes floods,
hurricanes, droughts and many other types of catastrophes. The UAW
submits that the devastation that has occurred in our steel and
airlines industries is no less worthy of federal assistance.
There is no danger this type of approach will create a ``moral
hazard'' leading to worse pension funding and more problems in the
future. This is because the UAW is proposing that the infusion of
general revenues to pay for the airline and steel pension liabilities
be coupled with the package of reforms to strengthen the funding of
other pension plans and with the new plan reorganization process that
will help troubled companies to continue their pension plans and reduce
the future exposure of the PBGC.
Conclusion
The UAW appreciates this opportunity to submit testimony to the
Committee on Education and the Workforce to express our views on the
Administration's proposals relating to the funding of pension plans and
the financial status of the PBGC. We urge the Committee to reject the
Administration's harmful and counterproductive proposals, and instead
to fashion a constructive package that will strengthen the funding of
pension plans, protect workers and retirees, provide stability and
predictability to employers that sponsor pension plans and encourage
them to remain in the defined benefit pension system, and place the
PBGC on a sound and sustainable path.
We look forward to working with Members of the Committee on
Education and the Workforce as you consider these important pension
issues. Thank you.
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