[Senate Hearing 108-285]
[From the U.S. Government Publishing Office]
S. Hrg. 108-285
SAFEGUARDING AMERICA'S RETIREMENT SECURITY: AN EXAMINATION OF DEFINED
BENEFIT PENSION PLANS AND THE PENSION BENEFIT GUARANTY CORPORATION
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HEARING
before the
FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY
SUBCOMMITTEE
of the
COMMITTEE ON
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 15, 2003
__________
Printed for the use of the Committee on Governmental Affairs
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WASHINGTON : 2003
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COMMITTEE ON GOVERNMENTAL AFFAIRS
SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
NORM COLEMAN, Minnesota DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama MARK PRYOR, Arkansas
Michael D. Bopp, Staff Director and Chief Counsel
Joyce A. Rechtschaffen, Minority Staff Director and Counsel
Amy B. Newhouse, Chief Clerk
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FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY
SUBCOMMITTEE
PETER G. FITZGERALD, Illinois, Chairman
TED STEVENS, Alaska DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
ARLEN SPECTER, Pennsylvania THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama MARK PRYOR, Arkansas
Michael J. Russell, Staff Director
Richard J. Kessler, Minority Staff Director
Tara E. Baird, Chief Clerk
C O N T E N T S
------
Opening statements:
Page
Senator Fitzgerald........................................... 1
Senator Akaka................................................ 4
WITNESSES
Monday, September 15, 2003
Malcolm Wicks, Minister for Pensions, British Government......... 6
Peter R. Fisher, Under Secretary for Domestic Finance, U.S.
Department of the Treasury..................................... 8
Steven A. Kandarian, Executive Director, Pension Benefit Guaranty
Corporation.................................................... 9
Christopher W. O'Flinn, Vice President, Corporate Human
Resources, AT&T, on behalf of the ERISA Industry Committee..... 23
Kathy Anne Cissna, Director of Retirement Plans, R.J. Reynolds,
on behalf of the American Benefits Council..................... 24
Norman P. Stein, Law Professor, University of Alabama, on behalf
of the Pension Rights Center................................... 26
JoOhn P. Parks, Vice President, Pension Practice Council,
American Academy of Actuaries.................................. 28
J. Mark Iwry, Senior Fellow, The Brookings Institution........... 30
Alphabetical List of Witnesses
Cissna, Kathy Anne:
Testimony.................................................... 24
Prepared statement........................................... 98
Fisher, Peter R.:
Testimony.................................................... 8
Prepared statement........................................... 43
Iwry, J. Mark:
Testimony.................................................... 30
Prepared statement........................................... 142
Kandarian, Steven A.:
Testimony.................................................... 9
Prepared statement with attachments.......................... 54
O'Flinn, Christopher W.:
Testimony.................................................... 23
Prepared statement with attachments.......................... 72
Parks, John P.:
Testimony.................................................... 28
Prepared statement with attachments.......................... 125
Stein, Norman P.:
Testimony.................................................... 26
Prepared statement........................................... 116
Wicks, Malcolm:
Testimony.................................................... 6
Appendix
Charts submitted for the Record by Senator Fitzgerald
Total Underfunding, Insured Single-Employer Plans............ 157
PBGC Net Position, Single-Employer Program, FY 1980-FY 2002.. 158
Uncertain Futures............................................ 159
Single-Employer Premium Income, FY 1992-FY 2002.............. 160
SAFEGUARDING AMERICA'S RETIREMENT SECURITY: AN EXAMINATION OF DEFINED
BENEFIT PENSION PLANS AND THE PENSION BENEFIT GUARANTY CORPORATION
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MONDAY, SEPTEMBER 15, 2003
U.S. Senate,
Subcommittee on Financial Management,
the Budget, and International Security,
of the Committee on Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2:31 p.m., in
room SD-342, Dirksen Senate Office Building, Hon. Peter G.
Fitzgerald, Chairman of the Subcommittee, presiding.
Present: Senators Fitzgerald and Akaka.
OPENING STATEMENT OF SENATOR FITZGERALD
Senator Fitzgerald. Good afternoon. The Subcommittee will
come to order.
Today, we are conducting an oversight hearing on the
challenges facing the Nation's defined benefit pension plans.
Broadly speaking, we will examine, one, the financial condition
of the Pension Benefit Guaranty Corporation, the PBGC, the
government-sponsored corporation which insures defined benefit
pension plans; two, how Congress can help shore up the PBGC;
and three, how Congress and the administration can help improve
the accuracy of the actuarial and funding practices of company-
sponsored plans and thereby help bolster the retirement
security of millions of American workers.
The Nation's private sector defined benefit pension system
is breaking down and needs to be fixed. Financially weak
companies have for years made pension promises that they could
not deliver and then simply dumped their unfunded pension
promises off onto the PBGC. The PBGC is now being crushed by
the weight of those claims.
Financially strong companies with responsibly managed
defined benefit pension plans should be concerned because they
may be unfairly forced to pay for the irresponsible promises of
the financially weak and irresponsible companies. And taxpayers
should be concerned, as well. If current trends continue, the
taxpayers themselves may someday be called upon to pay for the
pension promises of the irresponsible and financially weak
companies that dump their pension plans on the PBGC.
If the current situation seems reminiscent of the savings
and loan crisis of the late 1980's, that is because it is. And
just as weak S&Ls then sent hoards of lobbyists to Washington
asking Congress to prevent a day of reckoning, so, too, we now
have companies with weak and underfunded pension plans flooding
Congress with pleas for further indulgences. Let us hope that
this time around, Congress doesn't succumb to the siren song of
those who would urge us to roll the problem over into future
years.
The reason we are here now is because the problem has been
rolled over repeatedly in the past on the promise that things
will get better tomorrow. Well, in my judgment, tomorrow is
here, and we ought to act before it is too late.
Although pension fund assets totaled $1.6 trillion at the
end of 2002, estimates indicate that private sector defined
benefit pension plans are now collectively underfunded by
nearly $400 billion. As illustrated in our first chart at the
end of the dais, the level of underfunding has increased
sharply in the last 2 years.\1\
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\1\ Chart entitled ``Total Underfunding, Insured Single-Employer
Plans'' appears in the Appendix on page 157.
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The steel industry has already staked its claim against the
PBGC, taking the top three spots for the largest claims
submitted to the pension insurer in the last 2 years. Bethlehem
Steel, whose pension plan terminated in 2003, had $3.9 billion
in claims. LTV's pension plan terminated in 2002, with $1.9
billion in claims. And National Steel filed claims of $1.3
billion in 2003.
In its last filing prior to termination, Bethlehem Steel
reported that its pension plan was 84 percent funded on a so-
called current liability basis. The trouble is, if a plan
terminates, the legislative definition of current liability is
typically a figure that is far less than the actual amount of
money that is needed to pay the benefits that are owed. Thus,
it turns out that Bethlehem Steel's pension plan, which was 84
percent funded on a so-called current liability basis, was
actually only 45 percent funded on a termination basis. As a
result, the other companies that remain in the PBGC insurance
program, or perhaps even someday the taxpayers themselves, will
have to pay over 50 percent of the benefits which Bethlehem
Steel promised its workers but apparently never funded.
It is here worth noting that despite its remarkably low
level of funding, the laws currently on the books allowed
Bethlehem Steel to make no cash contributions whatever in the 3
years prior to its plan's termination.
The PBGC's financial health has deteriorated dramatically
in recent months, and I would like to refer you to the second
chart.\2\ The PBGC has experienced a swing from a $7.7 billion
accumulated surplus at the end of fiscal year 2001 to a $5.7
billion deficit as of July 31, 2003. This swing amounts to a
$13.4 billion swing within 22 months. The PBGC now faces its
largest deficit ever, with the likelihood of additional severe
losses in the immediate and intermediate future.
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\2\ Chart entitled ``PBGC Net Position, Single-Employer Program, FY
1980-FY 2002'' appears in the Appendix on page 158.
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PBGC's record losses are primarily attributable to the
recent termination of several severely underfunded pension
plans sponsored by financially troubled and bankrupt companies.
The combination of a decline in equity valuations and near
record low interest rates has resulted in a double whammy for
defined benefit pension plans.
Now, I would like to refer you to the third chart.\1\ This
is a chart that was copied with permission from the Wall Street
Journal. As it illustrates, the unfunded pension liabilities of
financially weak companies have soared in recent years. The
PBGC currently estimates that when it closes out its fiscal
year for 2003, the financially weak companies will have
underfunded their liabilities by $80 billion. This figure is up
$45 billion from last year's estimate.
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\1\ Chart entitled ``Uncertain Futures'' appears in the Appendix on
page 159.
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Further complicating the financial stability of the PBGC is
a steady decline of premium income. And for this, you can refer
to the fourth chart.\2\ It shows premium income declining from
$1.1 billion in 1996 to just $787 million in 2002. This
leveling off in 2002 results from more underfunded plans
qualifying for exemption from paying the variable rate premium
and an increasing number of plans being terminated. Premium
income in 2002 at $787 million was substantially less than it
was 10 years ago, in 1993, when it was $890 million. With a
shift to more defined contribution plans, such as 401(k)s, it
is unlikely that premiums will increase significantly in the
foreseeable future.
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\2\ Chart entitled ``Single-Employer Premium Income, FY 1992-FY
2002'' appears in the Appendix on page 160.
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At the same time that the PBGC's premium income has been
falling, the benefits that the PBGC has become obligated to pay
have been skyrocketing. Benefits paid in 1993 were $720
million. Last year, they were $1.5 billion, and this year, the
benefits paid are likely to reach $2.5 billion, over three
times the benefits paid in 1993 and many times the amount that
the PBGC is taking in in premium income.
Obviously and quite simply, the long-term survival and
success of the PBGC will be in jeopardy if the PBGC's premium
income continues to decline and its benefit payments continue
to rise at such a rapid rate. In my judgment, Congress must act
quickly to force companies which sponsor defined benefit
pension plans to do a better job of funding them, to stem the
tide of terminations by financially weak companies, and to
figure out a way to increase the PBGC's premium income,
probably by converting to a more sufficiently risk-based
system.
The plight of the PBGC is of great consequence to our
Nation. The PBGC's two insurance programs, the single-employer
insurance program and the multi-employer program, insure the
pension benefits of over 44 million participants in more than
32,000 private defined benefit pension plans. As many as 1.8
million of those participants are in my home State of Illinois.
In July of this year, the U.S. General Accounting Office
designated the PBGC single-employer pension insurance program
as ``high risk.'' This action is of particular significance
because it marks only the third time in the history of the
GAO's high-risk list that an agency or program has been added
independently of the GAO's biennial report.
We cannot lose track among the acronyms and dollar figures
of the toll this issue might have on working people across
America. It is cruel and unacceptable to pull the rug from
under hard-working Americans by telling them some of their
deserved and promised pension benefits no longer exist. It is
also unacceptable to force the taxpayers to bail out the PBGC.
These principles should be our ground zero commitment to
American workers, that government has an obligation to make
companies live up to the promises they make to their workers
and that it has an obligation to protect taxpayers from picking
up the tab of a failed system.
United Airlines, headquartered in my State, which on a
termination basis has underfunded its pension plan by some $7.5
billion, has recently been pushing for legislation that would
allow it to receive a 5-year moratorium on deficit reduction
contributions and then have 20 years thereafter to amortize the
additional unfunded liability accruing during that time. The
big risk, of course, is that United's pension plan would become
even more unfunded and would eventually be terminated. The PBGC
would then be stuck with hefty liabilities, United workers
would lose benefits, and other companies would be forced to pay
for one industry's unfunded promises.
Special interest legislation such as that proposed by
United is exactly the sort which, in my judgment, will make the
problem worse. As one of our distinguished witnesses said
earlier this year, when you are in the hole, the first rule is
to stop digging. I plan to do what I can to make sure that
Washington does no more digging.
Clearly, changes are needed in the defined benefit pension
system. In July, the administration proposed changes to improve
the accuracy and transparency of pension information. The
administration proposal focuses on three key areas: Improving
the accuracy of plan sponsors' liability calculations,
increasing the transparency of pension plan information, and
strengthening pension funding to protect workers and retirees.
We look forward to hearing more about this proposal from our
witnesses.
In addition, this hearing will explore a number of issues
and challenges facing the Nation's pension system and the PBGC.
These include replacement of the 30-year Treasury bond rate;
strengthening of funding rules; accurate measurement of assets
and liabilities; current liability versus termination
liability, the definition of those terms; declining PBGC
premium revenue; increasing the extent to which pension
contributions are tax deductible--they are only deductible now,
as I understand it, up to the amount of your required
contributions and it is difficult to make excess contributions
in years that the company is doing well; the allowance of so-
called alternative investments that some companies have been
allowed to make; and another hot topic, the effect of cash
balance plans.
We look forward to hearing the views of our witnesses on
these and other issues affecting the Nation's pension system as
well as their recommendations on ways to ensure the financial
stability of the PBGC and the pension plans of companies the
PBGC insures. At stake is nothing less than the financial
security of millions of Americans who rely or are planning to
rely on their company funded pension plans in their retirement
years.
Now, before turning to our witnesses for testimony, I want
to introduce the Ranking Democrat. Senator Akaka has arrived,
and I thank Senator Akaka for being here. Would you like to
make an opening statement.
OPENING STATEMENT OF SENATOR AKAKA
Senator Akaka. Yes, Mr. Chairman. I want to say good
afternoon to you and our panelists. I want to thank you, Mr.
Chairman, for holding this hearing today and, again, thank our
witnesses for sharing their insights with us this afternoon.
Although more employers offer defined contribution plans
such as a 401(k) plan than defined benefit plans, we must
ensure that the Pension Benefit Guaranty Corporation is able to
protect the retirement security of the estimated 34 million
hard-working Americans participating in single-employer defined
benefit pension plans. I am concerned that the PBGC lacks
sufficient reserves to carry out its statutory responsibility
of providing workers with protection when their former
employers are no longer able to support their retirement
benefits.
Comptroller General David Walker recently testified before
the House Committee on Education and the Workforce about the
risks that PBGC is and will be facing. He noted that in fiscal
year 2002, PBGC's termination of defined benefit plans offered
by Anchor Glass, Bethlehem Steel, and Polaroid accounted for a
$4.2 billion loss to PBGC. While these plans represent the
largest losses to PBGC in their respective industries, they are
just three examples. In its latest review, GAO found that many
of the single employer defined benefit plans are severely
underfunded, which led Congress' non-partisan auditor to place
the PBGC on its high-risk list in July.
The PBGC has faced deficit situations before. The agency
was on the high-risk list in 1990, due to weak funding rules
and ran deficits during the mid-1980's and early 1990's.
Congress enacted legislation to strengthen minimum funding
standards and to enhance rules on variable rate premiums paid
by defined benefit pension plans.
Although the PBGC has faced problems before, to which
Congress responded, it is critical that we act once again to
ensure that PBGC is self-supporting. Most PBGC revenue comes
from premiums set by Congress and paid by the private sector
employers that sponsor defined benefit plans. Other sources of
income are assets from terminated plans taken over by the PBGC,
investment income, and recoveries collected from companies when
they end underfunded pension plans.
To shore up the financial foundations of PBGC, there must
be greater transparency of plan information so that workers
understand the stability of their plans and the contributions
that are made by their employers. Employees should know if the
company for which they work will be unable to pay employee
pensions.
There are those who believe we should adopt limited, short-
term changes to pension funding rules and just wait out the
current economic conditions that pose risks to the PBGC. Others
recommend measures to address loopholes in funding rules. The
administration has proposed changing the rate at which an
employee's contribution is calculated over the long term. It is
crucial that we work together to secure the retirement security
of American workers.
I look forward to discussing what can be done to guarantee
that companies honor their pension commitments, and when these
promises cannot be met, what must be done to make sure that the
PBGC is sufficiently funded to carry out its statutory mission
as insurer of the private defined benefit pension plans.
We look forward to the hearing and the testimony, Mr.
Chairman, and I thank you for holding this hearing.
Senator Fitzgerald. Thank you, Senator Akaka.
I am pleased to tell you that we have a special guest here
from the Nation of Great Britain, our great friend and ally,
Malcolm Wicks, who is the Pension Minister in British Prime
Minister Tony Blair's cabinet. Mr. Wicks was appointed in 2001
as the Parliamentary Under Secretary of State for Work at the
Department for Work and Pensions. Mr. Wicks has had a
distinguished career of service to the British Government, also
having served as Parliamentary Under Secretary of State for
Lifelong Learning at the Department for Education and
Employment, and as Chairman of the Education Select Committee,
and as a Member of Parliament.
Mr. Wicks, we are delighted to have you here. I understand
that you are working on some new legislation in Great Britain
and I would like to give you the opportunity to address the
panel for as long as you would like to go on. Thank you very
much for being here.
TESTIMONY OF MALCOLM WICKS, MINISTER FOR PENSIONS, BRITISH
GOVERNMENT
Mr. Wicks. Mr. Chairman, may I first of all thank you, and
indeed Senator Akaka, for this opportunity to say a few words.
I promise to detain the Subcommittee only a few minutes,
because knowing the Subcommittee system in my own country, you
have important work to do and important witnesses. But I thank
you for your kindness and courtesy in giving me this
opportunity, which as both a Parliamentarian myself and as a
Minister, I genuinely regard as a very great privilege.
May I say that the close relationship between Great Britain
and the United States extends to social policy, and I think we
are increasingly learning a great deal from one another. We are
here on a relatively short visit to Washington, essentially to
listen and learn.
The United Kingdom, like your country, finds itself in a
situation where pensions as increasingly rising up the agendas
that count, particularly the agenda of public opinion. Our
demographics are not dissimilar. I am struck by the fact that
whereas 100 or so years ago, many working Americans, and
certainly many working Britains, never outlived their working
life. Today, there is the concept of retirement and, indeed, in
the 21st Century in the United States and Great Britain, many
of our citizens may have retirements lasting 20, or indeed,
increasingly 30 or more years. So this couldn't be more
important as an issue.
I do not believe that we face crisis. I think we overuse
the term ``crisis.'' We should use it properly and in context.
But we all face in our democracies very formidable challenges.
Like in the United States, in the United Kingdom, there is
concern about occupational pensions, defined benefit or final
salary schemes, and we plan to legislate in our coming session
in the House of Commons to introduce what we will call pension
protection funds, drawing very much on the experience of the
Pension Benefit Guaranty Corporation. And may I say that we
have had useful meetings in Washington over the last few days,
not the least with Steven Kandarian and his colleagues this
morning. I am grateful to him and, indeed, the cooperation they
are giving to our officials who are asking some very detailed
and searching questions about the Corporation's operation.
Senators I am very grateful for this opportunity and thank
you very much.
Senator Fitzgerald. Minister, thank you very much for being
here. We thank you for joining us today, and good luck on
setting up your form of the PBGC. Thank you very much.
At this time, I would like to welcome our first panel with
two distinguished witnesses. Our first witness is the Hon.
Peter R. Fisher, the Under Secretary for Domestic Finance of
the U.S. Department of the Treasury. Secretary Fisher was sworn
in on August 9, 2001. His experience and understanding of the
financial markets proved invaluable as our Nation and our
financial system responded to the terrorist attacks of
September 11.
Secretary Fisher's accomplishments include his leadership
in helping to improve and streamline our government's fiscal
practices and policies, enacting terrorism risk insurance,
promoting job creation and investment, developing policies on
deposit insurance reform, advocating for enhanced disclosure by
government-sponsored enterprises, working to prevent identity
theft, and improving Federal debt management practices.
Under Secretary Fisher will be departing the Department of
Treasury in the next month. In my judgment, his departure will
be a great loss for the entire Federal Government.
I would also like to welcome Steven A. Kandarian, who is
the Executive Director of the Pension Benefit Guaranty
Corporation. Prior to joining the PBGC, Mr. Kandarian was
managing director and founder of Orion Partners, L.L.C., in
Boston, Massachusetts, where he managed a private equity fund
specializing in venture capital and corporate acquisitions. He
also was managing director of Lee Capital Holdings, a private
equity firm also based in Boston, and was an investment banker
in Houston, where he specialized in mergers and acquisitions
and initial public offerings.
The government is especially grateful to have an individual
with such extensive private sector financial experience at the
helm of the PBGC during this difficult time. His grasp of the
issues surrounding the pension system and the PBGC, as well as
his innovative ideas, are a significant and timely addition to
the public policy debate underway.
Again, I want to thank you both for being here and I would
tell Minister Wicks, it won't be rude if you get up. You don't
have to wait through the whole hearing, and you can stay as
long as you like, but we will not feel hurt if you have other
commitments, so thank you.
Under Secretary Fisher.
TESTIMONY OF PETER R. FISHER,\1\ UNDER SECRETARY FOR DOMESTIC
FINANCE, U.S. DEPARTMENT OF THE TREASURY
Mr. Fisher. Thank you, Mr. Chairman, and thank you for
those generous and kind introductory remarks. Mr. Chairman,
Ranking Member Akaka, I am very pleased to be here with Steve
Kandarian to discuss our defined benefit pension system. Mr.
Kandarian will discuss the current financial condition of the
PBGC and I would like to discuss the administration's proposals
for strengthening the long-term health of our defined benefit
pensions.
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\1\ The prepared statement of Mr. Fisher appears in the Appendix on
page 43.
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Pension plan underfunding and the PBGC's deficit are
symptoms of a serious structural problem in the defined benefit
pension system. As you noted, Mr. Chairman, the GAO reached the
same conclusion in placing the PBGC's single employer insurance
program on its list of high-risk government programs. The time
to fix the system is now, while the problems are still
manageable.
In our view, the best way to protect the PBGC is to be sure
that pension plans are adequately funded. This is also the best
way to provide pension security for our Nation's workers and
retirees.
Pension problems can be placed into two priority
categories, comprehensive reform issues that need our prompt
attention and more narrowly-focused issues that need Congress'
immediate attention.
Comprehensive reform issues include strengthening pension
funding rules, reexamining and updating certain key actuarial
assumptions, and shoring up the PBGC's insurance program
overall. My written testimony, which I ask to be included in
the record, outlines the full range of issues the Congress and
the administration will need to address to achieve
comprehensive reform. Let me now just summarize the three areas
where we have asked Congress for immediate action.
First, accurate measurement of pension liabilities. Fixing
the pension funding rules won't help unless we ensure that we
are accurately measuring the pension liabilities on which those
rules rely. Our first step is replacing the 30-year Treasury
rate required under current law to be used as a discount rate
in measuring pension liabilities for minimum funding purposes.
The administration recommends that pension liabilities
ultimately be discounted with rates drawn from a corporate bond
yield curve that takes into account the term structure of
pension plans' liabilities. For the first 2 years, pension
liabilities would be discounted using a blend of corporate
rates. A phase-in to the appropriate yield curve discount rate
would begin in the third year and would be fully applicable by
the fifth year. Using the yield curve is essential to match the
timing of future benefit payments with the resources necessary
to make those payments. Our proposal is consistent with well
established best practice in financial accounting, can be
readily implemented by plan sponsors, and provides a transition
period for implementation.
Second, we think we need greater transparency of pension
funding. There is no requirement under current law that workers
and retirees covered by defined benefit pension plans receive
regular, timely information on their plan's financial
condition. We propose to remedy this by requiring that each
year, sponsors provide each participant with the value of his
or her pension plan's assets and the level of liabilities
measured on both a current liability and a termination basis.
Not only will disclosure of this information be valuable for
those covered by plans, it will provide a powerful incentive
for sponsors to keep their plans well funded.
Third, containing the risks to the PBGC of underfunded
plans. Underfunded plans sponsored by financially weak firms
which pose the greatest risk to the PBGC have few restrictions
in expanding benefits. The administration proposes to add some
protection for the PBGC by strengthening the restrictions on
those plans in making new promises.
In summary, Mr. Chairman, we face a real problem today. We
need to act this year in these three areas that I have
identified and then we will have provided the basis for which
to move on to comprehensive reform. The administration stands
ready to work with this Subcommittee and the rest of Congress
to accomplish these goals. Thank you very much.
Senator Fitzgerald. Thank you, Mr. Secretary.
Mr. Kandarian, you may proceed with your opening statement.
TESTIMONY OF STEVEN A. KANDARIAN,\1\ EXECUTIVE DIRECTOR,
PENSION BENEFIT GUARANTY CORPORATION
Mr. Kandarian. Mr. Chairman, Ranking Member Akaka, thank
you for holding this hearing on pension funding and the
financial health of PBGC.
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\1\ The prepared statement of Mr. Kandarian with attachments
appears in the Appendix on page 54.
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Defined benefit pension plans continue to be important for
the retirement security of millions of Americans, but recently,
there has been a sharp deterioration in plan funding.
In July, the administration proposed improving the way
pension liabilities are calculated, increasing the transparency
of pension funding, and providing new safeguards against
underfunding by financially troubled companies. The
administration also called for funding reforms.
In addition to urging the Subcommittee to act upon these
important measures, my testimony today will focus on PBGC's
financial condition, plan underfunding, and some of the
challenges facing the defined benefit system.
During fiscal year 2002, PBGC's single-employer insurance
program went from a surplus of $7.7 billion to a deficit of
$3.6 billion, a loss of $11.3 billion in just 1 year. Based on
our latest unaudited financial report, the deficit has grown to
$5.7 billion as of July 31, 2003.
As you just mentioned, GAO recently placed PBGC's single-
employer insurance program on its high-risk list. My hope is
that GAO's high-risk designation will spur reforms to better
protect the retirement security of American workers.
As of December 31, 2000, total underfunding in the single-
employer plans was less than $50 billion. Because of declining
interest rates and equity values, as of December 31, 2002, 2
years later, underfunding exceeded $400 billion, the largest
number ever recorded. Even with the recent rises in the stock
market and interest rates, PBGC projects that underfunding
still exceeds $350 billion today.
Because large plans typically invest more than 60 percent
of their assets in equities, there is a mismatch between
pension assets and pension liabilities, which tend to be bond-
like in nature. With the market conditions of the last 3 years,
this asset-liability mismatch caused many plans to become
significantly underfunded.
In addition to massive underfunding and vulnerability to
equity market volatility, the defined benefit system faces
other serious challenges, including adverse demographic trends
and weaknesses in the pension funding rules. While each of
these challenges is discussed in my written testimony, given
time constraints, I will focus on four key weaknesses in the
funding rules.
First, the funding targets are set too low. Employers can
stop making contributions when the plan is funded at 90 percent
of current liability, a measure that reflects past legislative
compromises, not the amount of money needed to pay all benefits
if a plan terminates. As a result, employers can stop making
contributions before a plan is sufficiently funded to protect
participants.
Second, the funding rules often allow contribution
holidays. Even seriously underfunded plans may not be required
to make annual contributions. Bethlehem Steel, for example,
made no cash contributions to its plan for 3 years prior to
plan termination, and the U.S. Airway pilots' plan had no cash
contributions for 4 years before the plan was terminated.
Third, the funding and premium rules do not reflect the
risk of loss to participants and premium payers. The same
funding and premium rules apply regardless of a company's
financial health, but PBGC has found that nearly 90 percent of
the companies representing large claims against the insurance
system have had junk bond credit ratings for 10 years prior to
termination.
Fourth, because of the structure of the funding rules,
contributions to plans can be extremely volatile. After years
with little or no required contributions, companies can be
faced with sharp spikes in funding. Although our complicated
funding rules were designed in part to minimize the volatility
of contributions, the current rules have failed to achieve this
goal.
Mr. Chairman, we must make fundamental changes to the
funding rules that will put underfunded plans on a predictable,
steady path to better funding. The administration is working on
comprehensive reforms that will get pension plans better funded
and eliminate some of the risk shifting and moral hazard in the
current system.
It is our hope that these reforms will put the defined
benefit system on a stable footing for the long term. If
companies do not fund the pension promises they make, someone
else will have to pay, either workers in the form of reduced
benefits, other companies in the form of higher premiums, or
taxpayers in the form of a PBGC bailout. We should not pass off
the cost of today's problems to future generations.
Thank you, Mr. Chairman, for inviting me to testify. I will
be happy to answer any questions.
Senator Fitzgerald. Thank you both very much. We appreciate
your being here and appreciate your good insights in your
opening statements.
Mr. Kandarian, I would like to begin with you. You focus
mainly on trying to shore up the funding of the plans
themselves. You noted that the funding targets are probably too
low. I do want to address that later on, but at the outset, I
want to address the problem with your premium revenue being so
low compared to the benefits you are paying out. Obviously,
that is not sustainable.
You are getting less premium revenue now than you were 10
years ago and claims against you, or benefits that you have to
pay out, have tripled, roughly, in the last 10 years. If I
understand it, you are going to pay out about how much this
year, $2.5 billion, is that correct?
Mr. Kandarian. Our current run rate, Mr. Chairman, is $2.5
billion. We anticipate in fiscal 2003 that number going up to
perhaps $2.9 billion.
Senator Fitzgerald. In this fiscal year?
Mr. Kandarian. Fiscal 2003, beginning October 1. Oh-four,
pardon me.
Senator Fitzgerald. OK. So going up to $2.9 billion next
year?
Mr. Kandarian. Yes.
Senator Fitzgerald. And how much in premium income do you
have?
Mr. Kandarian. We are taking in just under $800 million a
year in the single-employer program currently.
Senator Fitzgerald. OK. So you are eating into your trust
funds to pay these claims on an ongoing basis. Obviously, this
isn't sustainable for the long term, barring some kind of
incredible upturn perhaps in the equity funds that you hold,
but those are only about 30 percent of your overall trust
funds, isn't that correct?
Mr. Kandarian. Yes. Our equity investment allocation is
approximately 30 percent today. What would have to happen for
us to get back in balance would be a dramatic improvement in
our equity returns, premium income that would continue at these
levels or perhaps higher because the variable rate premium may
kick in a little bit stronger, but we still do not anticipate
under the current rules that that number would exceed $1
billion. It would be less than $1 billion a year.
Senator Fitzgerald. OK. So the question I have for you is
are our insurance premiums sufficient? It doesn't look to me
like they are anywhere close to being sufficient.
Mr. Kandarian. Well, the administration is looking at all
these different avenues. We have no specific proposal at this
point in time on premiums. But, really, the first thing I hope
we can do is, in addition to studying the correct measure of
these liabilities, is to get these plans better funded so that
when they do come into this agency, that instead of coming in
50 percent funded, they come in 80 or 90 percent funded if
there is a need for PBGC insurance.
Senator Fitzgerald. So it is more manageable if you have to
take them over. What about funds that are leaving the PBGC?
There is an increasing number of pension plans that are just
leaving the fund. They are switching their workers over to
defined contribution plans. That is also having a negative
effect on your premium income, correct?
Mr. Kandarian. Well, the premiums are determined based upon
numbers of plan participants. That number has pretty well
leveled off. So it is driven by that number as well as the
variable rate premium amount.
So what really happened in the last few years was the
variable rate premium was coming down, largely because of the
way it is measured and because plans did get well funded in the
late 1990's with the stock market boom. But those rules have a
lag effect to them. The variable rate premium will start to
increase, but again, we don't anticipate it going up above $1
billion, which at one point we did have in premiums.
Senator Fitzgerald. Now, I was struck by the figures that
Bethlehem Steel, prior to its termination, claimed to be 84
percent funding in its last filing prior to termination----
Mr. Kandarian. Right.
Senator Fitzgerald [continuing]. On a so-called current
liability basis, and current liability, it is a very
complicated definition. I tried to unscramble it yesterday. I
had several staff members working on it and we found why there
is a whole industry of ERISA lawyers out there and why they are
highly compensated. It is very convoluted. It is not a simple
definition. I gather there are all sorts of different ways of
calculating it.
But the bottom line is, whatever current liability is in
ERISA, it seems to be something less than the actual amount of
money you have to put in to pay off the claims. You found that
Bethlehem Steel was 84 percent funded on a current liability
basis, but on a termination basis, only 54 percent funded.
Mr. Kandarian. Yes, Senator. What occurred there was, as
you mentioned, the definition of current liability is
dramatically different, especially in the case as we had here
recently with declining asset values and declining interest
rates, which drove up stated liabilities. So the definition of
current liability results in these much higher stated amounts
of funding, and, in fact, for the 5 years before Bethlehem
Steel came into our agency on a terminated basis, the company
made no variable rate premium payments to us.
The variable rate premium is supposed to reflect these
underfunded plans, and here was the largest underfunding the
agency ever had taken on in its history by a factor of two and
there was no variable rate premium paid to the agency for 5
years. In addition, over the last 5 years, only about $40
million of cash contributions went into this pension plan that
was $4.3 billion underfunded when it finally came in. So the
current liability measure can really be misleading when a
company is in a death spiral and terminates its pension plan.
Senator Fitzgerald. Now, some of the later witnesses are
going to criticize you for focusing on termination liability
because they say that that is a number taken by calculating the
cost of buying annuities from insurance companies when
terminating a plan and that, in fact, you don't buy annuities.
So why do you think termination liability is an important
number?
Mr. Kandarian. Well, when a company terminates its pension
plan, even if the company doesn't go out of business, they can
do what is called a standard termination simply to exit the
system and start using some other vehicle, perhaps 401(k)s.
They go to insurance market and they price out these
liabilities in the marketplace and they basically defease these
liabilities with insurance companies, and the question becomes,
even for a company that is going out of business, if they had
enough money in the pension plans, and occasionally one of
several pension plans may have enough money in it to buy a
standard termination annuity in the group annuity market, those
obligations, those liabilities won't come to the agency under
law. They will go right to the insurance market.
So it is really an apples-to-apples basis of what did these
liabilities cost in the private marketplace, and for the
government to say, we are going to price these liabilities
higher or lower, I think would be wrong.
Senator Fitzgerald. Senator Akaka, you may have questions
you want to ask at this point, and then I will ask some
questions of Secretary Fisher.
Senator Akaka. Thank you very much, Mr. Chairman. I do have
some questions.
If I may digress for just a moment, I would like to thank
Mr. Fisher for bringing the challenges of the Postal Service to
the attention of the administration. As the former Chairman of
the Committee's Postal Subcommittee, I appreciate your interest
and efforts in this area.
I also want to add my welcome to Minister Wicks for being
here with us today.
Now, let me turn to the issue at hand--the need to protect
workers' pensions insured by the PBGC. As the testimony of our
panelists will show, there are diverse views and little
consensus on how the complex issues of pension funding should
be approached. I am concerned that the administration proposal
could unfairly impact unionized workers.
The Department of Labor estimates that 69 percent of
unionized workers have pension plans as compared to 14 percent
of non-union workers. The U.S. manufacturing industry is more
likely to employ a unionized workforce because manufacturing
jobs are more likely to be unionized and are more likely to
offer pensions.
Mr. Fisher, do you believe that the administration's
proposal would affect union employees' pension plans?
Mr. Fisher. Senator, first, let me be very clear. We
certainly hope that it will affect their pension plans by
getting them better funding.
The connection, as I see it, is that there are in heavy
manufacturing a tradition of higher rates of unionization and
of older workforces at this point, and we have already at this
hearing discussed some of the problems in the steel industry.
If we don't get to accurate measurement of pension liabilities,
those very workers are the ones who will be most greatly at
risk to have underfunded pension plans.
So we think it is of paramount importance to make sure that
their retirement security is as protected as we can make it to
get to accurate measure of liability and that motivated the
administration's proposals we made in July.
Senator Akaka. Thank you, Mr. Fisher.
Mr. Kandarian, in your testimony, you mentioned that PBGC
is responsible for paying current and future benefits to
783,000 people in over 3,000 terminated defined benefit plans.
Furthermore, PBGC operates from premiums that it receives from
program participants, and your testimony states that PBGC
receives no Federal tax dollars.
My question to you today is, what incentives could keep
employers' well-funded pensions with PBGC?
Mr. Kandarian. What incentives could keep companies in the
defined benefit system? I think probably the best incentive is
to get this system on a stable footing, and there are a number
of ways to do that.
First, as Secretary Fisher has mentioned, having accurate
measure of liabilities is very important. Disclosure is very
important, and if I may digress to the question you asked Mr.
Fisher a moment ago, it is important for union members to know
the status of their pension plans. Are they well funded? Are
they underfunded?
If all they hear are these current liability-type numbers
that the Chairman mentioned, they may be misled into thinking
that if a company is in trouble financially, that their plan is
well funded and they won't lose any benefits, when, in fact,
their plan may be highly underfunded if the plan terminates.
Our disclosure proposals would enable workers to learn what the
real numbers are. It would enable unions, in particular, to put
pressure on companies potentially to make sure these plans are
properly funded.
So I think the proposals the administration has talked
about would be very beneficial to the system and many of the
workers that you are referring to and you are concerned about.
Senator Akaka. Mr. Kandarian, I have another question.
Since PBGC does not receive any taxpayer dollars and is not
backed by the Federal Government, how does the PBGC invest the
premiums that it receives from employers and does this strategy
need to be changed to address the additional benefit payments
as a result of the recent terminations of large underfunded
plans?
Mr. Kandarian. The narrow answer to your question is the
premium dollars are all invested in U.S. Treasury securities,
long-duration U.S. Treasury securities. Those are very safe, of
course. They aren't necessarily the highest returning
securities.
The broader question, I think, would be where are the other
dollars we have invested, and those are from the trust funds,
the plan assets that come in to us from a terminated pension
plan, and those dollars since 1994 have been invested largely
in the U.S. stock market. The PBGC Board is now considering
current investment policies and we anticipate soon that there
will be some feedback for the agency as to whether to retain
the existing direction or to modify that direction in any way.
Senator Akaka. Mr. Chairman, my time has expired. I have
further questions.
Senator Fitzgerald. OK. Thank you.
Mr. Fisher, I want to give you an opportunity to describe
the administration's proposal for having a yield curve that
would be used in making the calculations regarding a plan's
liabilities. Historically, we have used a 30-year Treasury
rate, and since you had a role in phasing out the 30-year
Treasury bond, now we are looking for a new benchmark and
corporate America would like to take advantage of corporate
bond yields, but the administration has proposed that we apply
a yield curve to more tightly estimate the liabilities a plan
faces. Could you explain the administration's proposal in that
regard?
Mr. Fisher. Certainly. Thank you, Mr. Chairman. The
administration has agreed with a number of members of the
pension community that moving to a corporate interest rate more
closely tracks the quality of the promise. That is, a pension
liability is like the liability of a company, so like a bond
rating that a company issues, a pension promise is a promise
made by a corporate sponsor. So at a conceptual level, we share
that it would be appropriate to move from the U.S. Treasury
yield curve, which reflects the full faith and credit of the
United States, to a high-grade corporate credit.
However, in the interests of accuracy, we think that it is
very important, indeed, incumbent on us, to reflect the time
structure of the benefit promises that companies have made.
Using a single interest rate really distorts, especially when
you use a long-term interest rate, distorts the valuation of a
series of promises or liabilities.
To use a very simple example, if I owe you $100 next year
and I also owe you $100 10 years from now, if we use a single
10-year rate to value both of those in present value terms, we
are going to significantly understate the value today of the
burden I face in paying you that $100 next year.
Given the demographics in our country of an aging
population, particularly in industries with defined benefit
plans, we think it is especially important to reflect these
payments that will be made over the coming years in coming to
an accurate measure of the pension plan.
Now, it is really--mechanically, it is a very simple two-
step process. Plan actuaries come up with estimates, and this
is the difficult part, the estimates of how many dollars have
to be paid out in each year, and they have to do that no matter
what interest rate is used. Once they come up with those
estimates of how many dollars are paid in 1, 2, 3, 4, or 5
years, they then have to apply an interest rate to discount
those to present values.
Well, at that step in the operation, you can apply the same
interest rate to all of the different annual payments and come
up with what we know will be an inaccurate measure, or you can
apply the correct interest rate, a 1-year rate for the 1-year
flow, a 5-year rate for the 5-year flow, and come up with the
most accurate measure of liabilities that we know of. This is
standard practice now in banking and in financial markets. We
think it is the right way for us to measure pension liabilities
to be accurate. This may seem complicated for the layman, but
for those whose job it is to value money sums across time, this
is really standard industry practice today.
Senator Fitzgerald. Well, the goal here is just to make the
judgment of the liabilities more accurate, isn't that correct?
Mr. Fisher. Absolutely, Senator.
Senator Fitzgerald. Why do you think anybody would oppose
making those judgments more accurate?
Mr. Fisher. Well, an uncle taught me--I had an uncle who
was a physicist--that habit is the most underestimated
variable. And in this area of pension accounting, there is a
habit of using a single interest rate for the last 30 years. It
was embedded in statute in 1987. I think financial market
practices have been evolving over the last 20 years and now it
is time for these statutes to catch up.
Senator Fitzgerald. Isn't it true, though, that the
Financial Accounting Standards Board is now referencing using
different discount rates depending on the maturity of the
obligation in the pension----
Mr. Fisher. I know they are in the process of reviewing
their rules, and just as we have been reviewing the statutory
framework, they have been reviewing the accounting framework.
We all know this is the best practice that we need to be
evolving toward.
Senator Fitzgerald. And, in fact, some actuaries presumably
do this. I believe I read somewhere that there is something in
the website of an actuarial association that refers to a way of
matching the maturity of the obligations with the fund's
assets. And so it is likely to become an increasing practice
and you are just trying to make it more accurate.
Now, I think the critics who are going to testify after
you, the one criticism that I suspect they will have of this
plan, is that the market for corporate bonds, especially long-
term corporate bonds, can be rather thin. So whatever yield
curve is out there isn't all that solid. Obviously, we don't
have as deep a corporate bond market as we do have in
Treasuries. Do you have a response to that criticism?
And would you only be talking about AAA-rated companies or
investment grade rated corporates? Obviously, they would
probably like the highest discount rate they could get, so
maybe they would even want the low investment grade corporates
to be used as a benchmark, but that is not what you have in
mind.
Mr. Fisher. No, Senator. First, let me be clear. If the
legislation is enacted as the administration has proposed, we
would imagine an extensive rulemaking process under the
Administrative Procedures Act, fully transparent for all
interested groups to comment and have an opportunity to look at
all the details of the index that we would create. That is step
one that I think is very important.
As I explained in my written testimony, toward the back of
a rather extensive testimony, I will concede, we do think that
a few adjustments will be necessary to deal with the problem
that there may be spotty liquidity along the yield curve. We
would not be adjusting for the level of rates. But we would
look to the Treasury yield curve for the structure of interest
rates, the shape of the yield curve, to make some adjustments,
as is very common in the creation of fixed-income indices in
our financial markets. I want to be very clear about that. That
is not a--we would look to high-grade corporate bond, whether
AAA or AA. We are not wedded to that, but that is the sort of
issue we would like to be fleshing out through----
Senator Fitzgerald. Do you have the power to promulgate
this rule now without Congress' authorization? You do have a
lot of power under the current ERISA law, don't you, to
reference----
Mr. Fisher. I don't believe that we would have the
authority under current law to create a curve and have the
curve be used in valuing the minimum funding requirements.
Senator Fitzgerald. OK. You have to have legislative help
on this and replacing the 30-year Treasury rate. We are now
using, is it 120 percent of the 30-year Treasury----
Mr. Fisher. Yes, that is----
Senator Fitzgerald [continuing]. Temporarily until
December, and we have got to have legislation before the end of
the year, and, in fact, the sooner the better so companies can
plan for their liabilities next year.
Mr. Fisher. Absolutely, Senator.
Senator Fitzgerald. I have a couple of more questions for
Mr. Kandarian. Right now, companies file a statement with you
that shows their termination liability, but that is kept secret
and it is not open to the public, not to stockholders of the
company, and not to plan members, is that correct?
Mr. Kandarian. Currently, there is a Section 4010 filing
that companies with more than $50 million in underfunding file
with us. So a plan has to be, generally speaking, one of the
larger plans and to be significantly underfunded and they file
this form with us which we typically receive within 3\1/2\
months of the year end.
Senator Fitzgerald. I am trying to figure out how it came
to the point that these filings are secret. Wouldn't it be in
the public's interest, particularly if you are a worker at the
company who is a participant in the pension plan, to know the
termination liability of the company?
Mr. Kandarian. I think the way it came about in the last go
around in the legislation was that companies were reluctant to
have this information in the marketplace, and they gave reasons
why, and that was the compromise at that point in time.
The administration, however, feels that at least some of
this data should be made public so that shareholders and
financial market analysts see this information, as well as
workers and plan participants.
Senator Fitzgerald. So in certain cases, this could be bad
news that is being kept from the public, whether from investors
or from members of the pension plan.
Do you have any idea--I believe there were some articles
last Friday, a Reuter's one I recall specifically, that
discussed that United Airlines is considering terminating its
plan and dumping its liabilities on the PBGC. My understanding
is that the claim the PBGC filed in the bankruptcy court
earlier this year was for a $7.5 billion claim for termination
liability.
What would be the effect on the PBGC if a pension plan the
size of United and as underfunded as United's plan were to be
terminated and handed off to you?
Mr. Kandarian. Well, we don't today anticipate that all the
pension plans of United would come to us in the near future,
but there is no way for us to control that, obviously, and that
will play out in the marketplace with United's efforts to
emerge from Chapter 11. So we are hopeful that they can do
that, but we don't have much control over that at our agency.
The $7.5 billion number was a contingent claims or
placeholder that we put into the record in a bankruptcy
proceeding should the plans terminate and come to us. But it
wasn't our stating that we thought it was going to come to us.
In terms of what it would do to our financial situation, as
we mentioned, we are currently $5.7 billion in deficit. You
correctly note our claim is for--our contingent claim is for
$7.5 billion. However, we don't guarantee 100 percent of
benefits and we cap out benefits, especially for highly
compensated individuals, which some people in the airlines
would fit into. So I don't have an exact number for you today,
but we would anticipate more than $5 billion would be the
impact upon us should all those plans come to the agency.
Again, we are not predicting that to be the case. I am simply
trying to be responsive to your question.
Senator Fitzgerald. OK. I know the administration hasn't
made a proposal in this regard, but it seems to me that the
premiums should be more risk-based than they now are. Could you
explain to me to what extent premiums for PBGC insurance are
risk-based today? I analogize to banking, where they went to
risk-based premiums a number of years ago after the S&L
debacle.
Mr. Kandarian. Well, today there are, again, two elements
to the premiums paid to PBGC under a single-employer program.
One is a fixed rate, $19 per participant. There is no risk-
based component to that. It is regardless of how risky a plan
is to the agency.
The variable rate premium is nine-tenths of one percent of
so-called underfunding, but it is defined, again, based upon
this current liability-type measure, which as we know, is
wanting oftentimes during situations of bankruptcy and
termination. So there is very little truly risk-based aspects
to the current----
Senator Fitzgerald. Isn't that kind of unfair to the--you
do have many well-funded, responsibly managed plans in your
fund, and isn't it unfair that they are paying the same
premiums as some terribly underfunded pensions?
Mr. Kandarian. Well, certainly those who are paying the $19
and are overfunded and are AA or AAA credits, I imagine are
paying more than what would be a typical private sector
insurance rate for their plan in many cases.
Senator Fitzgerald. It strikes me--I know that you guys
have received a lot of flack from some in the corporate world
that you are being real tough on the pensions, but I am giving
you ideas on how you could be a whole lot tougher, aren't I.
Mr. Fisher.
Mr. Fisher. If I could, Senator, just to jump in here, to
clear something----
Senator Fitzgerald. Maybe you could pull the microphone a
little closer.
Mr. Fisher. Just to underscore a point I think Director
Kandarian made a few minutes ago, there really are two ways to
come at this. You are suggesting that premiums are too low
given the level of risk. The other side of it, we would all
rather see less risk in the system.
So one reason why the administration hasn't yet come
forward with an issue on--recommendation on the premiums is to
see how far can we go in reforming the measurement and the
funding rules and then come back and look at the balance of how
much risk is in the system, what should the premium structure
be. But we fully take your point and we believe that a thorough
review of the premium structure should be part of any
comprehensive reform.
Senator Fitzgerald. So the passage of your plan, if it
helps to shore up the funding of the pension plans that are out
there, could ultimately save the members in the PBGC from
having to endure a premium increase and could save them money.
Mr. Kandarian. I think that is right, yes. And I have
testified several times before Congress in the last 2 years. I
think in virtually all my testimonies, I have always started by
saying our first choice is for the dollars to go into the plans
to better fund the plans.
Senator Fitzgerald. Rather than just into premiums. Now, I
have to ask a question about two things, Mr. Kandarian. What
about non-standard assets? I understand that in some cases, you
have allowed some companies to put stock that is not publicly
traded, for example, into their pension plans in lieu of cash.
When do you allow that, and is it an exemption to rules that
allows you to allow alternative investments?
Mr. Kandarian. Let me start by saying those are Title I
issues under ERISA, which is really the jurisdiction of the
Department of Labor that is not here today. I don't want to
speak for them, but I can give you some general guidelines and
information on that.
Current law prohibits companies from putting in more than
10 percent of employer securities into their defined benefit
pension plans in terms of assets. So we already have that
safeguard.
In addition, there are securities that sometimes require
exemptions to place into these pension plans, regardless of the
10 percent level, because they may not be tradable or one thing
or another. And that is looked at on a case-by-case basis by
the Department of Labor.
Senator Fitzgerald. In general, companies have to put cash
or marketable securities into their plans?
Mr. Kandarian. Yes.
Senator Fitzgerald. Do you ever require plans to
collateralize, in effect, their unfunded pension liabilities?
Can you take security? Can you take a lien on any corporate
assets as a means of enforcing the company's viability?
Mr. Kandarian. I am trying to think here, but the place
where I recall seeing security use would be in the cases of
waivers granted by the IRS. Oftentimes in granting the waiver,
the IRS will require securities being put up in lieu of cash.
Senator Fitzgerald. But by and large, when a company files
bankruptcy and terminates its plan, you don't have any security
for the unfunded liability, by and large.
Mr. Kandarian. In bankruptcy, we are generally an unsecured
creditor, that is correct. There are some exceptions to that,
non-bankrupt subsidiaries. We have a stronger standing in
bankruptcy as to non-bankrupt subsidiaries. We also have a
stronger position in bankruptcy for missed minimum funding
payments and for missed premiums to the agency. But generally
speaking, that is a very small percentage of the exposure the
agency faces. Typically, we get back less than 5 cents on the
dollar in bankruptcy on the underfunded amount.
Senator Fitzgerald. My final question, and then I will turn
it over to Senator Akaka if he has any more questions of this
panel, would be for Secretary Fisher. My understanding is that
during the 1990's, Congress closed some opportunities in the
tax code that companies formerly had to put more than the
required payments into their pension plans and to get a tax
deduction for those payments, and apparently during the 1990's,
we severely cut down the extent to which companies can get a
tax deduction for contributions to their pension plans. And as
a result, in the late 1990's when corporate America was
generally doing very well, we didn't see any excess
contributions to pension plans in the aggregate, and in fact,
my understanding is there is an excise tax if you put more than
your minimum necessary payments into your pension plan.
Has the administration looked at all about perhaps
enhancing the deductibility of corporate contributions to their
pension plans?
Mr. Fisher. Yes, Mr. Chairman. The administration has said
that we are prepared to review the deductibility after we get
to accurate measurements. We don't think it is appropriate to
have their cake and eat it, too, to have measures of funding as
you have described of current liability, suggesting they are
fully funded, when deep down on some other basis we realize
they may not be as well funded.
If we can get to a shared understanding of an accurate
measure of the liability, then we are prepared to review the
deductibility to try to provide a smoothing--excuse me, that is
an inappropriate term---- [Laughter.]
Less volatility in funding provided by companies. So we are
prepared to review that. One does have to take care in
designing those rules, especially for small companies----
Senator Fitzgerald. There can be abuses.
Mr. Fisher. There can be abuses, and that is something the
IRS and the Treasury will look out for. But we are prepared to
review all those rules in the context of accurate measures of
liabilities.
Senator Fitzgerald. Senator Akaka, I don't know if you have
any questions.
Senator Akaka. Thank you, Mr. Chairman. I just have three
more questions.
Secretary Fisher, the administration's proposal would use
corporate bond rates for calculating future pension
liabilities. As a result, businesses would be able to make
smaller contributions to worker pensions and assume a higher
rate of return. There are concerns that this proposal could
drive pension deficits higher at the expense of workers'
pension savings. American taxpayers would be at risk if PBGC is
underfunded and cannot pay the claims of failed pensions.
What will it cost taxpayers if PBGC cannot pay the amount
necessary to cover pension claims?
Mr. Fisher. Senator, if I could take your question in two
parts, first, I want to be very clear that the administration
does not support simply using a corporate bond rate. If we
simply took a single long-term corporate bond rate, it would
have the implications that you suggest of potentially leading
to underfunding.
We feel, however, if you tie that to the use of the yield
curve, as I have outlined, then we will get to better funding
over time and more accurate funding for those plans with
younger or older workforces. They will be appropriately funded.
So the two go together.
As the colloquy has already, I think, demonstrated, as has
been brought out, the PBGC does not carry the full faith and
credit of the United States. It is a government corporation,
but does not have a call on the Treasury. So any underfunding
of the PBGC, its deficit, which began to eat into its ability
to meet its obligations, would be an issue that would be before
Congress. It would be up to the then-Congress, together with
the administration, to decide on whatever legislation would be
needed.
But in the absence of adequate funding to meet payments,
which we don't foresee in the immediate future, but given the
current deficit looks to be in the years ahead, in the absence
of that, something would have to give. Congress would have to
enact legislation.
Senator Akaka. Thank you, Secretary Fisher.
Director Kandarian, the management consulting firm Towers
Perrin estimates that the administration's proposal to alter
funding rules could cut pension contributions by $50 billion
annually during the first 3 years, which would leave more
pensions underfunded.
The question is, in your opinion, what effect would the
administration's proposal have on PBGC's deficit?
Mr. Kandarian. As Mr. Fisher has just testified, really,
what we are trying to do is get the accurate measure of these
liabilities. So if we can get that right measure utilized, over
time, we believe these plans will be better funded.
Now, I will also say that the administration's proposal and
other proposals up on the Hill contemplate a long-term
corporate bond rate for 2 years, which is not the
administration's long-term proposal but it is a transition
proposal, and yes, that would provide some funding relief in
the short term, but we think that makes some sense given
current economic situations, environment.
Senator Akaka. Mr. Kandarian, you and the Comptroller
General testified 2 weeks ago before the House Committee on
Education and the Workforce. At the hearing, Mr. Walker
recommended that Congress consider ways to strengthen the
funding of pension plans and to improve transparency by making
information available to workers on the health of their pension
plans. What are your views on these recommendations?
Mr. Kandarian. Well, as I mentioned before, we welcomed
GAO's analysis. We have read it carefully. The administration,
as Mr. Fisher has noted, is currently undertaking the task of
fundamental review of the entire system, including the funding
rules and including a number of factors, and we hope to have
our proposal, our broader proposal outlined in the not-too-
distant future.
Senator Akaka. I thank you, Mr. Secretary and Mr. Director,
for your responses. Thank you, Mr. Chairman.
Senator Fitzgerald. Thank you, Senator Akaka.
Mr. Kandarian and Secretary Fisher, thank you so much for
being here. We will take your written testimony and submit that
for the record. Secretary Fisher, we wish you the best of luck
after you leave the Treasury at the end of this month. As I
said at the start of the hearing, I think you have done a
wonderful job and should be commended for it, so best of luck
to you. Thank you both very much for testifying.
Now, we can bring the second panel of witnesses up to the
table and we will take about a two-minute recess just so that
people can stretch before we start with their testimony. Thank
you.
[Recess.]
Senator Fitzgerald. I would now like to resume our hearing,
and I would like to introduce our second panel of witnesses.
Christopher O'Flinn is the Chairman of the ERISA Industry
Committee and he serves as the Vice President of Corporate
Human Resources at AT&T. Mr. O'Flinn also is a trustee of the
Employee Benefits Research Institute and a member of the
Advisory Council on Pensions to the New York State Controller.
Kathy Cissna is the Director of Retirement Plans for R.J.
Reynolds. She is here today to testify in her capacity as a
board member of the American Benefits Council, ABC, which
represents Fortune 1000 companies and service providers. ABC's
members either sponsor directly, administer, or service
retirement, health, and stock compensation plans covering more
than 100 million Americans.
Professor Norman Stein, who I gather his mother lives in
Illinois, he told me, is here today. Did you grow up in
Illinois? Were you born in Illinois?
Mr. Stein. Well, it depends when you think childhood ends.
I was 21 when my parents moved here, but they would say I grew
up there.
Senator Fitzgerald. You left when you were 21?
Mr. Stein. No, I moved there when I was 21.
Senator Fitzgerald. Oh, you moved there when you were 21.
Well, that is still enough to make you an honorary constituent,
even though I gather you are in Alabama.
Professor Stein is here today to speak on behalf of the
Pension Rights Center. He is currently the Director of the
Pension Counseling Clinic and the Douglas Arant Professor of
Law at the University of Alabama.
John Parks is the Vice President of the Pension Practice
Council for the American Academy of Actuaries. In addition, he
is the President of MMC&P Retirement Benefits Services and is
an enrolled actuary with 41 years of experience in the
actuarial and employee benefits field.
J. Mark Iwry is a non-resident Senior Fellow in the
Brookings Institution's Economic Studies Program. Mr. Iwry
served as benefits tax counsel of the U.S. Department of the
Treasury from 1995 to 2001. Prior to joining the Treasury
Department, he served as a partner in the law firm of Covington
and Burling and specialized in pensions and other employee
benefits.
Again, I would like to thank all of you for being here to
testify. In the interest of time, the Subcommittee would
appreciate it if you could submit your full statements for the
record and try and summarize your full statements in about a 5-
minute opening statement. You could talk off the top of your
head, as I am sure each of you are able, because you know this
area so well, and we would appreciate that.
Mr. O'Flinn--I know a lot of Flinns. I have never met an
O'Flinn, but I gather that is probably Irish, like Fitzgerald.
TESTIMONY OF CHRISTOPHER W. O'FLINN,\1\ VICE PRESIDENT,
CORPORATE HUMAN RESOURCES, AT&T, ON BEHALF OF THE ERISA
INDUSTRY COMMITTEE
Mr. O'Flinn. Your guess is correct, Mr. Chairman. Let me
add that my son is about to become a constituent when he moves
to Chicago on the first of October.
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\1\ The prepared statement of Mr. O'Flinn with attachments appears
in the Appendix on page 72.
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Senator Fitzgerald. Oh, great.
Mr. O'Flinn. Thank you for the opportunity to address the
Subcommittee on behalf of ERIC. ERIC has a unique interest in
today's hearing. Our members are all large employers who
sponsor defined benefit plans, and as a group, they actually
pay the bulk of the premium taxes collected by the PBGC. So our
overriding interest is in maintaining both a vital defined
benefit plan system and a financially sound PBGC along the
lines that the Chairman outlined at the beginning of the
hearing.
If we have a message that we would like to leave with the
Subcommittee today, it would be that any delay in enacting a
composite corporate bond rate as a replacement for the 30-year
Treasury bond which takes effect in January 2004 for the
current liability test will prevent firms from contributing to
the economic recovery and will drive even the largest U.S.
companies away from the defined benefit system.
We think that failure to act to replace the 30-year bond
means that many companies will face totally unnecessary and
draconian cash calls beginning in the spring of next year. And
moreover, as we speak today, chief financial officers across
the country are being advised of the likelihood of these cash
calls, and that is having a chilling effect on continued
benefit accruals, Mr. Chairman, under the defined benefit
system, and also a chilling effect on other alternative uses
for that cash, including investment in new jobs and investment
in all capital investment, which is essential for our continued
recovery.
In other words, we think the time to act to replace the 30-
year bond is now and only then will we have a stable platform
of rational interest rates to move forward to consider other
challenges in the pension law, some of which were very well
described by Director Kandarian and Secretary Fisher.
I would like to turn to the PBGC itself and echo the words
of Minister Wicks that crisis is a word that should be used
very carefully. We think that, as Secretary Fisher said when he
began his testimony, there are issues and they are manageable
now if we address them. Our concern is not that the issues are
wrong or not there, but that they be addressed in a logical way
that gives light to all the connected issues around them.
Our written testimony goes into greater detail. I would
like just to mention a few points in that testimony.
First, even after becoming trustees of the Bethlehem Steel
plan, the PBGC has a funded ratio of over 90 percent. And
according to our calculations, as supplemented by the American
Society of Pension Actuaries, the assets of the PBGC divided by
the current level of benefits, inflated as they are, are
sufficient to pay, continue to pay benefits for approximately
18 years. That is assuming no growth in the assets and no
additional premiums.
In other words, Mr. Chairman, while this can be compared by
some people to the S&L debacle, we don't agree with that. We
think it is a little bit early to use that kind of description.
The agency is not insolvent. It is a long way from becoming
insolvent. And yet, there are issues and they are serious
issues affecting the pensions of Americans, including our
employees, and we are concerned about them. But we want to move
deliberately because of the related and consequential effects
of some of the things being proposed by the administration.
I would only mention a couple of these in the interest of
time, but one of them is that the interest rate not only
affects perhaps the premium structure of the plan and perhaps
what might be the funding for corporations, but it affects the
benefits of the employees who are relying on the PBGC to pay
benefits.
If the PBGC uses an overly conservative interest rate to
discount--to arrive at the present liabilities of the benefits
it has taken on, it will allocate more assets than necessary to
pay for the guaranteed benefits, which has the highest order of
priorities, or one of the highest order of priorities against
the assets, leaving less assets available for the non-
guaranteed benefits, meaning that those benefits won't get paid
to the employees. So it is very important to get this discount
rate right for all of the people who are interested in the
calculation, and that is not only the PBGC and the plan
sponsors but the employees themselves.
Thank you, Mr. Chairman. I would be delighted to answer
questions.
Senator Fitzgerald. Thank you, Mr. O'Flinn. Ms. Cissna.
TESTIMONY OF KATHY ANNE CISSNA,\1\ DIRECTOR OF RETIREMENT
PLANS, R.J. REYNOLDS, ON BEHALF OF THE AMERICAN BENEFITS
COUNCIL
Ms. Cissna. Mr. Chairman, thank you for the opportunity to
appear today on behalf of the American Benefits Council, which
is, as you said, a public policy organization representing
principally Fortune 500 companies and other organizations that
assists employers of all sizes in providing benefits to
employees.
---------------------------------------------------------------------------
\1\ The prepared statement of Ms. Cissna appears in the Appendix on
page 98.
---------------------------------------------------------------------------
Like you, the Council and its members are very concerned
about the health of our defined benefit pension system, a
system that is facing an unprecedented series of threats that
require immediate policy action.
In our view, the most pressing of these threats is the need
to replace the obsolete 30-year Treasury bond interest rate for
pension calculations with a realistic rate. Because of the
discontinuation of the 30-year Treasury bond, its yield has
reached historic lows and no longer correlates with rates on
other long-term bonds. The use of this rate inflates pension
contributions in excess of what is necessary to fund promised
benefits.
In 2003 and 2004 alone, contributions by Fortune 1000
companies are projected to exceed $80 billion per year, more
than four times what was required just 2 years ago. More than
half of these contributions are attributable to the
inflationary effect of the broken 30-year Treasury rate.
Today's artificially inflated funding requirements harm
employees, employers, and the economy at large. Facing pension
contributions many times greater than anticipated, employers
are having to defer steps such as hiring workers, building new
plants, and pursuing research and development. For some
employers, these inflated pension contributions are too much to
bear and they have been forced to terminate or freeze their
pension plans.
The Council strongly endorses replacing the obsolete 30-
year Treasury rate with a blend of high-quality corporate bond
rates. A conservative corporate bond rate would be transparent,
not subject to manipulation, and provide the kind of
predictability that is necessary to plan pension costs. The use
of a corporate bond rate, which is much more conservative than
what pension funds will actually earn, would also ensure that
plans are funded responsibly.
This is why stakeholders from across the ideological
spectrum, from business owners to organized labor, agree that a
corporate bond rate should replace the 30-year Treasury rate.
Senator Judd Gregg, Chairman of the Health, Education,
Labor, and Pensions Committee, has introduced a bill, S. 1550,
that would do exactly that. We urge the Members of this
Subcommittee to cosponsor S. 1550 and we recommend its prompt
adoption by the Senate.
Separately, the Treasury Department has put forward a
proposal to utilize the so-called yield curve concept to
replace the 30-year Treasury rate. While a fully-developed
yield curve proposal still has not been issued, it does appear
to involve a significant change to a more volatile and
complicated structure under which the applicable interest rates
would vary with the schedule and duration of payments due to
each plan's participants.
We believe the yield curve and the associated proposals to
eliminate interest rate averaging would exacerbate funding
volatility and increase complexity, all for only a marginal
potential increase in accuracy.
Despite inclusion in legislation to be considered by the
Senate Finance Committee as soon as Wednesday, there are still
a host of unanswered questions created by the yield curve. In
fact, the development of the methodology for developing the
yield curve is yet undefined, as is its impact on funding rules
in general or plans or participants. It leaves employers with
many unanswered questions and is unrealistic to believe that
all of the outstanding issues could be addressed in the short
time available.
To the extent that this type of major overhaul of our
pension funding rules is considered, it should be done as a
part of a more fundamental and thoughtful review by Congress.
In the interim, we should be cautious of enacting the yet
unexplored yield curve approach, but should move urgently to
replace the 30-year Treasury rate with a corporate bond blend
before any more American workers are frozen out of secured
pensions.
I also want to briefly address the concerns that we have
heard raised about the financial status of the PBGC. While the
PBGC's deficit should be considered seriously, we do not see
cause for alarm. Indeed, the PBGC has operated in a deficit
position throughout much of its history.
The PBGC has total assets in excess of $25 billion and
earns money from investments on those assets. While the
liabilities, as we have heard, exceed those investments, the
pension obligations underlying those abilities come due not
immediately, like the situation might have been in the S&L
crisis, but over many decades. The relatively modest size of
the PBGC's deficit in relation to its assets ensures that it
will remain solvent far into the future, a point that the PBGC
itself has acknowledged repeatedly.
The best recipe for a stable PBGC is to encourage healthy
companies to remain in the defined benefit system, an aim that
will be furthered by the policy changes we are advocating
today.
Thank you for this opportunity to appear, and I would be
happy to answer questions.
Senator Fitzgerald. Thank you very much. Professor Stein.
TESTIMONY OF NORMAN P. STEIN,\1\ LAW PROFESSOR, UNIVERSITY OF
ALABAMA, ON BEHALF OF THE PENSION RIGHTS CENTER
Mr. Stein. Mr. Chairman, Members of the Subcommittee, I am
Norman Stein. I teach at the University of Alabama School of
Law and also direct the law school's pension counseling clinic,
whose funding from the Administration on Aging has made it
possible for us to help hundreds of individuals with their
pension problems. I appear here today on behalf of the Pension
Rights Center, a consumer organization dedicated to protecting
the pension rights of workers and their families.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Stein appears in the Appendix on
page 116.
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The issues you are looking at today fuse together broad
issues of economic and social policy with arcane concepts of
actuarial science. But these issues are critical, not only to
the participants in defined benefit plans and to their
families, but also to the economic and moral health of our
Nation. The decisions that we make about this program today
will determine the long-term sustainability of the traditional
defined benefit plan, which is a crown jewel of our private
sector retirement system.
The first question I want to address briefly is whether the
Pension Benefit Guaranty Corporation is really in crisis. The
PBGC's deficit status is not a new phenomena. As the GAO has
reported, over the last decade, the program has swung from a
huge deficit to a huge surplus and now back to a deficit. How
has this latest swing happened? Conventional wisdom has it that
there are three significant reasons for PBGC's current large
deficit.
First, economic factors have resulted in the termination of
several defined benefit plans with large unfunded liabilities.
Second, low interest rates have increased the present value of
the PBGC's benefit obligations. Third, the PBGC's investment
portfolio has declined in value. Some have called the
combination of these three factors a perfect storm.
But how long will this perfect storm last? Two of the three
storm fronts, low interest rates and low equity returns, may be
transitory. Interest rates might rise and equity markets might
rebound. If this happens, the PBGC's financial situation might
improve dramatically and this perfect storm may turn out to
have been the perfect tempest in a teapot.
I want to turn now to funding of defined benefit plans. The
current funding rules for defined benefit plans have not proven
adequate to ensure that all defined benefit plans will be
sufficiently well funded to satisfy their benefit commitments.
I want to highlight two observations from our testimony, and
not the observations where we happen to agree with the
witnesses who just spoke but the two where we differ.
First, some have suggested that the interest rate for
discounting plan liabilities be increased from the 30-year
Treasury rate to long-term corporate bond rates. The result of
such a change in many cases would be a reduction of a firm's
plan contributions and an exacerbation of plan underfunding. We
would urge that the appropriate discount rate should be pegged
to riskless or nearly riskless instruments, such as government-
issued bonds, because after all, the participants in the system
perceive their guaranteed benefits as being without risk.
The inappropriateness of the corporate bond rate can be put
in perspective by looking at how the use of such a rate would
affect PBGC's own liabilities. I have spoken with several
actuaries who estimate that such an alchemic change would
reduce PBGC's aggregated liabilities by between 5 and 15
percent, substantially reducing or perhaps almost eliminating
the PBGC's current deficit, which after all is the reason we
are here today.
Second, the administration has proposed that plan
liabilities be discounted to present value using a yield curve
derived from interest rates on high-quality corporate bonds.
For some plans, a yield curve based on corporate bond rates
would actually reduce funding obligations, which we think is
counterproductive to the goal of improving overall 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.
I want to turn now briefly to some of our observations on
other issues relevant to the PBGC. First, to strengthen the
PBGC, Congress in the future might consider allocating
appropriations to the PBGC from general revenues. Such
appropriations are, we believe, justifiable, since many of the
funding issues that defined benefit plans are today
experiencing have resulted from the low interest rates created
by Federal fiscal policy and the decision by the Federal
Government to stop issuing 30-year Treasury obligations. And as
you have already suggested, Mr. Chairman, to some extent, we
have a tax today already, but it happens to be on those people
who sponsor healthy defined benefit plans and it might be
fairer to have that burden spread to a broader tax base.
Second, to stem the flight of employers from the defined
benefit system and leaving the system's unfunded liabilities
for those employees who remain in the system, we might also
consider imposing an exit charge or withdrawal liability when
firms terminate their defined benefit plans.
Third, rules should be adopted to deter practices where
firms siphon off plan assets to non-pension purposes in years
when economic conditions are favorable, thus diminishing the
plan's cushion for harder economic times.
Finally, some have suggested reducing the interest rates
used to value single-sum payments from pension plans. While the
Pension Rights Center has never been an advocate of lump sum
distribution options, it has always taken the position 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 the bargain they made with
their workers.
I would be happy to take any questions. Thank you.
Senator Fitzgerald. Thank you, Professor. Mr. Parks.
TESTIMONY OF JOHN P. PARKS,\1\ VICE PRESIDENT, PENSION PRACTICE
COUNCIL, AMERICAN ACADEMY OF ACTUARIES
Mr. Parks. Chairman Fitzgerald, thank you for inviting me
to testify on defined benefit pension plan funding. It is a
personal honor of a lifetime for me to be here.
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\1\ The prepared statement of Mr. Parks with attachments appears in
the Appendix on page 125.
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My name is John Parks and I am Vice President of the
Pension Practice Council of the American Academy of Actuaries.
The Academy is a nonpartisan public policy organization that
represents actuaries and assists the public policy process
through the presentation of clear and objective actuarial
analysis.
The combined impact of the decline in the equity market and
reduced interest rates are currently creating a funding
challenge for defined benefit pension plans in our country. It
is important also to remember that for at least the last 10
years, there has been a steady shift away from the guaranteed
retirement income from defined benefit plans and toward the
self-annuitization through defined contribution plans.
The danger in this transfer of financial mortality risks to
individuals is largely unseen because the people affected have
mostly not yet retired. We must deal, therefore, not only with
the current financial conditions, but also with the longer-
range challenges facing defined benefit plans in general.
It is a critical part of this retirement economics
challenge to see that defined benefit plans are supported and
plan sponsors are provided with the incentive to maintain and
cultivate these programs. Some special advantages of these
plans include, for employees, a secure, stable income
guaranteed for life, and a reduction in the spreading of
mortality and investment risk. For employers, these plans
provide contribution flexibility and maintain a stable
workforce. For the Nation, defined benefit plans help to reduce
our dependence on social programs, such as Medicare, Medicaid,
and Social Security, and they reduce poverty among the elderly.
In 1975, just after the Employee Retirement Income Security
Act we signed into law, 40 percent of the labor force
participated in DB plans and 16 percent participated in a DC
plan. Today, however, the reverse is true. Only 21 percent
participate in a DB plan while 46 percent participate in
defined contribution plans. Our concern is not just the funding
of DB plans. Our concern is the survival of the DB plans as a
primary source of financial security for retirees.
The first issue I would like to discuss is funding. We must
simplify the rules. Years of almost annual amendments to ERISA
have continually increased the administrative burdens on those
who try to maintain defined benefit programs. Those companies
who sponsored DB plans are now questioning the future of their
programs under the current financial strains of the economy,
mandated rigid and short-range irrational minimum and maximum
funding requirements, arcane pension laws and regulations.
Simplification is necessary to reduce the regulatory cost of DB
plans and level the playing field and provide a viable system
with stable rules to attract new plan adoption, all of which
are needed to meet the financial security of retiring
Americans.
Just one quick example. There are 13 different amortization
rules for paying off liabilities in the funding code under
Internal Revenue Code Section 412. Our suggestions include
complete rewriting of the minimum funding standards and
providing for fewer and faster amortization periods.
The second funding concern is the maximum tax deductible
contribution limitation. These funding rules create volatile
contribution patterns and discourage adequate funding margins.
Almost by definition, the rules inhibit contributions when the
economy is strong and require substantial contributions when
the economy declines and plan sponsors can least afford them.
Some of our suggestions for revising these rules include
increasing tax deductible contribution maximum to reflect
increases in unfunded liability, allowing all negotiated
benefits to be reflected, reflecting lump sum payments in
current liability, and allowing a deduction for normal costs in
all years.
The next funding concern are the rules relating to
withdrawals from pension plans. Incentives for employers to
increase their funding margins may not work unless we also
address the one-sided nature of the funding equations.
Employers who try to protect the plan by making additional
contributions have very little opportunity to use those
contributions if it turns out they weren't needed. Our
suggestions would be only to allow reversions if assets exceed
some very high threshold, such as 150 percent of current
liability.
Fixing the discount rate--current law defines this interest
rate in terms of 30-year Treasury notes. This rate is used for
the determination of cash contributions, variable PBGC rates,
and other key pension calculations. They have been artificially
depressed, rising the current measure of costs associated with
plans. Our recommendation is that a replacement benchmark using
high-grade long-term corporate bonds is a reasonable proposal
consistent with the intended measurement. However, while the
various funding rules are studied, the period of temporary
enactment should be 5 years rather than 2 or 3 years as
proposed.
In summary, defined benefit plans, once the most common
form of retirement security for American workers, have lost
much of their attraction for corporations. The exodus of the
PBGC premium payer, a risk that has not been receiving proper
attention regrettably continues. The complicated solvency rules
with 3 years of low interest rates and market returns have
created a funding crisis. At the same time, plan participants
are starting to appreciate the value of being covered under a
DB plan. The high risk of personal ruin through self-
annuitization is yet to be fully realized.
In our haste to fix the funding crisis, we must be careful
not to create an environment that discourages the continuation
of existing DB plans. Thank you.
Senator Fitzgerald. Thank you very much, Mr. Parks. Mr.
Iwry.
TESTIMONY OF J. MARK IWRY,\1\ SENIOR FELLOW, THE BROOKINGS
INSTITUTION
Mr. Iwry. Thank you, Mr. Chairman. Having spent much of the
previous decade in the Treasury Department regulating private
pensions and benefits, including involvement in the previous
efforts a decade ago to reform the pension funding rules and
shore up PBGC's finances, I am convinced, Mr. Chairman, that
Congress does have to act both in the short- and long-term
here, but that there is no ``silver bullet,'' no simple
solution to these problems. That is because Congress has to
take into account several different interests that are highly
legitimate, that are in tension with one another, and that must
be balanced against one another.
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\1\ The prepared statement of Mr. Iwry appears in the Appendix on
page 142.
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Congress needs to begin with short-term funding relief and
then follow on with permanent, comprehensive improvement of the
funding rules that would specifically require more adequate
funding over the long term to protect workers' retirement
security, with special attention to reducing chronic
underfunding. And as Mr. Kandarian and Mr. Fisher suggested,
Congress needs to improve disclosure, both the transparency and
the promptness of disclosure regarding the material facts of
pension plan funding.
At the same time, Congress needs to take into account the
potential impact of large funding demands on a plan sponsor's
overall financial condition and on economic growth. It has to
minimize funding volatility for plan sponsors so that the
required increases in funding from year to year follow a
reasonably smooth path.
As Mr. Kandarian has said, the deficit reduction
contribution, that is, the minimum funding requirement that is
accelerated when a plan falls below a certain funded threshold,
is too volatile. It starts too late. It ends too early. The
funding path it puts plans on is not optimal.
The targets that the deficit reduction contribution are
keyed to need to be revisited. The rules allow inappropriate
holidays to companies that should be contributing, as the
Bethlehem Steel case illustrates. And employers are precluded
from funding for lump-sum distributions even if those impose
higher liabilities than the annuities that employees could
elect. IRS administrative guidance, notice 90-11, precludes the
company from actually taking into account the value of the
lump-sum distribution to the extent that it might impose more
of a funding obligation than a life annuity, and that needs to
be fixed.
While doing all of this, Congress needs to protect the
reasonable expectations of employees and retirees with respect
to their promised benefits, and to the extent possible, avoid
discouraging employees from continuing to provide pension
benefits. We also need to avoid penalizing those plan sponsors
that are funding their plans adequately and that are, like the
PBGC, not part of the problem but, in fact, part of what is
right with the system.
More generally, we need to continue encouraging employers
to adopt and to continue maintaining defined benefit pension
plans. This may suggest an emphasis on requiring sponsors to
fund adequately in preference to directly restricting their
ability to provide benefit improvements and in preference to
curtailing the PBGC's guarantee.
To that end, I think that the defined benefit system would
benefit from a resolution of the cash balance controversy that
would settle the law governing these plans in a reasonable way.
A major portion of the defined benefit universe in recent
years has taken the form of cash balance plans, as hundreds of
plan sponsors have shifted from the traditional defined benefit
plan to this new hybrid format. The precise application of the
governing statutes to these plans has been the subject of
uncertainty, litigation, and controversy, as you know, Mr.
Chairman.
I suggest that Congress could and should resolve the cash
balance controversy in a way that gives older workers
substantial protection from the adverse effects of a conversion
while allowing employers to maintain cash balance plans without
concern that they would be treated as if they were age
discriminatory or otherwise in violation of the law, and that
allows employers the reasonable flexibility that they need to
change their plans, to make amendments going forward, and the
flexibility they need to determine how, but not whether, to
protect older workers in these conversions.
I will be happy to answer any questions, Mr. Chairman.
Senator Fitzgerald. Thank you very much, Mr. Iwry.
Ms. Cissna and Mr. O'Flinn, Mr. Iwry suggested that he felt
that Mr. Kandarian and Secretary Fisher were correct in calling
for enhanced disclosure and transparency. What is wrong with
enhanced disclosure and transparency insofar as don't we want
pension plan beneficiaries to know the status of the plans they
are in and don't we want shareholders of a corporation to know
the full extent of any problems that a company may have in an
underfunded pension plan?
Ms. Cissna. I think it would be erroneous to say that
anybody is not in favor of accurate disclosure. I think the
only thing that concerns Council members is that good
transparent disclosure be properly representative to the people
it is being directed to.
I personally, as a plan sponsor, as a plan administrator,
am concerned that certain levels of panic could be created by
inappropriate disclosures to the extent that participants in a
plan might begin doing irresponsible things, like taking lump-
sum distributions when perhaps that is not in their best
interest, because as you mentioned yourself, the rules for how
you determine what is underfunding are so complicated that most
of our participants don't really appreciate them.
Senator Fitzgerald. Mr. O'Flinn.
Mr. O'Flinn. I would agree with Kathy's comments, Mr.
Chairman. First of all, I would also agree with the prior panel
that there is a need for additional disclosure. For example,
under the current disclosure rules dictated by FASB, you would
be hard pressed to estimate the future cash contributions
required to the plan. So if you were interested in the free
cash flow of the company, you basically might be missing a big
element unless you hired actuaries to dig through the material
and make their own estimates.
So we would agree, there is need for additional disclosure.
The particular disclosure that--we think that we would like to
hear what FASB has to say about that. They are aware of these
problems. They have an ongoing task force addressing them. If
there is a theme to the overall hearing, Mr. Chairman, that we
think fits here, it is what is the rush? Let us let the experts
fully flesh out everything that happens from what is being
proposed here before we commit to a specific set of actions.
And in terms of the termination benefits, termination
benefits basically evaluate the plan as if everyone is leaving
the day of the valuation. So all of the early retirement
benefits, which normally would not be used, since most people
retire later than the early retirement benefits, come into play
and explode the liabilities of the plan.
Senator Fitzgerald. But when a plan terminates, don't you
often have people leaving, people retiring early, taking money
right away? So if the company goes bankrupt and terminates its
plan, don't you have a flood of claims all of a sudden on the
plan?
Mr. O'Flinn. Yes, you do, but let me take some figures from
the PBGC's last annual report. They ensure $1.5 or $1.6
trillion in benefits and approximately $35 billion of that,
which is a little bit more than 2 percent, is underfunding
attributable to so-called financially weak companies. Now, for
disclosure on those 2 percent, should everyone behind the $1.6
billion [sic] do an evaluation and publicize it as if they were
going to go out of business tomorrow when the likelihood of
that happening is extremely small?
Senator Fitzgerald. Mr. Iwry.
Mr. Iwry. Mr. Chairman, I think that the representatives of
the ERISA Industry Committee and the American Benefits Council
have a responsible and legitimate concern regarding the risk of
a type of disclosure that would be not constructive and not
helpful and potentially not cost effective. But I do think
there is a reasonable middle ground here.
We certainly need to improve disclosure and there are at
least two specific ways in which that could realistically
happen. One is where companies are already sponsoring very
underfunded plans. Right now, it is an aggregate of $50 million
of underfunding, which perhaps should be made more sensitive to
the actual extent of underfunding as a percentage rather than
just the absolute amount and maybe even sensitive to the
financial condition of the plan sponsor.
But we now have these disclosures that you alluded to
earlier that are confidential and that to the PBGC when
underfunding has exceeded a certain amount. Those ought to be
made public, but not to the extent they would compromise
proprietary corporate information, and that is a large part of
the concern that the plan sponsors have. You can disclose the
funded status of the plan. You can disclose the assets and
liabilities without disclosing the company's own finances in a
way that isn't already required to be disclosed by law.
Second, you can disclose liabilities in a more accurate
way.
Senator Fitzgerald. Isn't the problem that the financially
weakest companies don't want that information disclosed because
then everybody would know how weak they are?
Mr. O'Flinn. That is right, and I think also some
financially stronger companies don't want certain information
disclosed because of competitive considerations, where the
securities laws and other rules already require a certain
amount of disclosure. But certainly, we can have much improved
disclosure of the plans' funded status, not just information
provided to the PBGC, but provided to employees, investors, and
everyone else.
And then you could have termination liability, which as you
indicate, is often a realistic depiction of what would happen
if the plan actually terminated in the near future, reflecting
early retirements and plan shutdowns that don't get taken into
account under current, so-called current liability
determinations. You can have this termination liability as an
additional disclosure for companies that are less solid. That
is, one could consider whether termination liability ought to
be required to be disclosed once a company is either below
investment grade in its ratings or is otherwise--or is
relatively underfunded in its pension plans. In other words,
once a company ceases to be sound and soundly funding its plan,
employees have a different degree of interest in knowing what
might happen in the then somewhat more realistic scenario that
the plan would terminate.
Senator Fitzgerald. Professor Stein, you said in your
opening statement that you believed that we should not adopt a
high-grade corporate bond discount rate, that it should be
based on as riskless a rate as possible, on a Treasury note of
some kind. Given that we are losing the 30-year Treasury bond,
that it is being done away with and that it is more and more
scarce, are you suggesting that we start using intermediate
grade Treasuries as a discount rate?
Mr. Stein. Well, my solution would be to begin reissuing
30-year Treasuries and, in fact, reissuing bonds of even longer
duration. I think the government's decision to stop issuing 30-
year Treasury bonds, I think has had perhaps some good
consequences, which are some speculative potential good
consequences down the road, but I think they have also created
problems, particularly in the area of pension plans.
I think also for funding, there is some discussion now
among actuaries about whether plans should be funded in a way
similar to what the yield curve suggests, that there should be
more of a matching of assets with liabilities, and if that is
to happen, a lot of the way it is going to happen is because
the government starts issuing notes of longer duration.
Senator Fitzgerald. What happens, Ms. Cissna, if we do
adopt a high-grade corporate reference and then all of a sudden
the 30-year Treasury does come back? After all, Secretary
Fisher is leaving the Treasury at the end of the month and I
think he was one of the people who was behind doing away with
the 30-year Treasury. Then would you stick with the high-grade
corporates or would you want to go back to the 30-year
Treasury, even though it would increase your payments? Wouldn't
that be a better----
Ms. Cissna. Well, I think that that is somewhat
hypothetical and I am not sure that I am in any means able to
answer a hypothetical question like that. I still think that
you have to focus on the fact that the high-grade corporate
bond rate is still a very conservative rate when compared to
the way pension funds are actually going to be invested. And to
the extent that you have a divergence between the actual
investment ability of the plan and the way you have to value
its liabilities, these are the things that are going to lead
employers to be afraid of defined benefit plans, afraid of the
system, and to look more and more at freezing and terminating
plans.
Senator Fitzgerald. Mr. Parks, what do you think of the
Treasury's idea for using a yield curve?
Mr. Parks. Our concern about the use of a yield curve is
the implication of complexity in the calculations that it would
mandate for each individual and each pension plan. I am not
certain that long range, it might be a logical solution, but
the current set of funding rules as it relates to defined
benefit plans are already a collage of confusion, and I am
afraid that this imposition of the yield curve without knowing
the implications of all those confusing calculations that are
currently necessary is premature and we would like to have the
opportunity to study it in depth.
Senator Fitzgerald. But it is true that it is now
considered a best practice, isn't it, in the actuarial world to
try and match the liabilities with a similarly maturing asset,
is it not?
Mr. Parks. I believe that is a best practice in the
financial world. I am not sure that from the perspective of the
actuarial implications in a defined benefit pension plan we yet
know that.
Senator Fitzgerald. Would it concern you that if we don't
use a yield curve, we would just be adopting a higher discount
rate from corporate Treasuries than we have now with the
government risk-free Treasury bonds? If we just adopt a
corporate bond rate as our discount rate, we are just allowing
companies to put a whole lot less into their pensions, aren't
we?
Mr. Parks. Well, you can adopt a corporate bond discount
rate, adjusted in some way to compensate for that, such as
subtracting a certain amount of basis points or multiplying by
a percentage.
Senator Fitzgerald. I don't think that is what these
companies have in mind. [Laughter.]
Ms. Cissna. Mr. Chairman, if I could interject, I think
that our position would be that, as I mentioned, the corporate
bond blend is still a conservative approach to valuing the
liabilities of vibrant pension plans, and the more that we can
do to continue to support the defined benefit system and to
continue to allow employers to fund responsibly without being
burdened by the volatility and the unpredictability that may be
established through the use of a yield curve, we are going to
be better off.
Senator Fitzgerald. I wonder if Mr. Parks would like to
comment--I gather you have some great familiarity with ERISA.
You have to deal with it. Actuaries have to actually plod
through the statute and figure out what some of the
definitions, such as current liability, mean. The case of
Bethlehem Steel illustrates this well--in its last filing,
Bethlehem Steel on a current liability basis was 84 percent
funded. But then when the PBGC took it over, it found that it
was actually only 54 percent funded on a termination basis
because the problem is that the legislative definition of
current liability is really more a political definition as far
as I can tell than an actuarial definition.
The bottom line is, current liability under ERISA is
something far less than the actual amount of money that needs
to be put into the plan to pay the benefits that are owed. Is
that accurate? Have you figured out why this is so?
Mr. Parks. You are correct in analyzing that the current
liability definition is extremely complex. Actuaries love
complexity, but even to me, it is confusing.
But maybe perhaps the best way to describe it, and in a
broad way, the difference between the termination liability and
the calculation of current liability, with all of its
machinations, is that current liability assumes that the plan
is an ongoing entity and termination liability is the end of
the line and, therefore, you have to cash in the chips and
measure it at one point in time. On an ongoing basis, we can
consider factors such as rates of return which reflect the
equity markets. But on a termination basis, we have to pay the
piper and measure as of this point in time.
Senator Fitzgerald. Well, it seems to make sense, then, to
calculate it in both ways, right? Termination basis and the so-
called current liability and have disclosure of both in case
the plan does, in fact, terminate, like apparently United
Airlines is considering terminating and they have a termination
liability of $7.5 billion. Would any of you care to comment?
Mr. O'Flinn. I would, Mr. Chairman. First, Bethlehem Steel
and all the steel companies got some relief from the funding
rules when they were last revised in 1994, and to the extent
that contributed to their underfunding, I think it is a little
unfair to say the current law, which essentially does not
completely apply to them, is a reason for changing the current
law.
In terms of the disclosure, I wonder what the purpose of
the disclosure is. What is the purpose of the vast majority of
companies disclosing a liability which the high probability is
they will never pay, recognizing that it could have a chilling
effect on even creating that liability, which has certain
legitimate purposes. In other words, a lot of the liability is
early retirement benefits and they are very beneficial to
people who are being laid off from an ongoing concern.
Senator Fitzgerald. Don't we want the members in the plan
to pressure their companies to better fund their pensions and
don't we want to deter companies from promising things to their
workers that at the end of the day they can't deliver? Haven't
we been going on too long in this country with companies, maybe
in union negotiations, saying, hey, we can't give you a raise
this year, but I will tell you what. We will sweeten your
pension benefits. And the reality is, they have no ability to
ever pay those sweetened pension benefits. Aren't we just
allowing companies to make promises that they can't keep, and
then when the workers don't get their pension at the end of the
day, isn't the rug being pulled out from under them? Mr. Iwry.
Mr. Iwry. Mr. Chairman, that is why I suggest, consistent
with what you were saying earlier, that there be disclosure of
the liability under both scenarios, that is, ongoing and in the
event that the plan terminates--the current liability and the
termination liability, or liability on a termination basis--at
least in circumstances where the second scenario, that is, that
the plan will not continue, becomes more likely. Perhaps it is
a reasonable weighing of costs and benefits here to trigger
that second disclosure in circumstances where that scenario of
termination does become more realistic.
I would add, with respect to your broader point about the
negotiated increases, that in devising an appropriate policy to
restrain unfunded benefit improvements and to protect the PBGC
and ultimately the taxpayers from inappropriate shifting of
liability, we do need to take into account, in fairness, that
the union plans typically are so-called flat benefit plans.
That is, they pay a benefit equal to X-dollars per month for
each year that an employee works for the company. If the
employee's wages go up, as people's wages normally go up over
their career, that formula doesn't keep up with the wage
increases or with cost-of-living increases unless it is amended
from time to time to increase that dollar amount.
By contrast, in the salaried world, the plans are typically
based upon pay. They provide a pension that is a multiple of
people's final average salary or career average salary or make
contributions in a cash balance plan that are proportional to
that year's pay. So they amount to something like career
average salaries. So when that plan continues unamended, it is
keeping up with inflation and, indeed, it is keeping up with
salary increases in a way that the unionized flat benefit plan
is not.
And, of course, that has served the purposes of management
and unions over the years. The union has been able to negotiate
an increase every 3 or 5 years during their collective
bargaining and bring that back to their members. But to the
extent that it is just keeping up with cost of living or with
wage increases, we might want to take that into account when we
set a restraining policy there.
Mr. Stein. There is another side to that. We actually talk
about this also in our written testimony. But for the most
part, the kind of plans that Mark has just described,
negotiated plans and a flat benefit formula, the quirk in the
funding rules makes it--means you can't fund these inflationary
increases, which we know are going to happen, and in order to
kind of treat these plans the same way we would treat final pay
plans, you would probably want to address this on both the
funding side and the guarantee side.
Senator Fitzgerald. You can't fund benefit increases that
are going to take place because of inflation?
Mr. Stein. In a final pay plan, you effectively can. But in
these kinds of plans that Mark is describing, generally, you
cannot.
Mr. Iwry. Mr. Chairman, I think our point is--I agree with
Professor Stein--the union bargained plan cannot anticipate the
future negotiated increases, even though it is understood that
it is likely the plan will be updated to keep up with inflation
or wage increases. But until that increase has actually been
negotiated and gone into effect, the actuary can't anticipate
it in the funding. So the rules are skewed to some degree or
structured in a way that has the effect of discouraging
adequate funding.
That is not to say that is the only reason. In some cases,
management will choose not to fund those plans too much, partly
out of concern that if they create a surplus of assets in the
plan, then the union will come back and ask for increases
because the money is there. So there are a lot of dynamics
there.
What I am suggesting is, that in restraining increases that
may not be prudent and may not be sufficiently well funded to
be fully responsible, we take into account the desire, I think,
of everyone on this panel and the previous panel to maintain
the health of the overall defined benefit system and to
continue encouraging employers to sponsor and improve defined
benefit plans.
Senator Fitzgerald. What about all the exemptions and
loopholes that have developed in recent years? We talked about
Bethlehem Steel not making any payments for 5 years. That was
apparently the result of the last time Congress amended ERISA
in 1994. It seems like that was a very unwise amendment that we
gave at the time. Does anybody know specifically where that
exemption is in the law and shouldn't those loopholes be
closed? Professor Stein.
Mr. Stein. There are a number of ways in which both the
variable premium structure and the deficit reduction
contribution don't work exactly as we would like them, and they
tend to be fairly technical.
One problem with the deficit reduction contribution is if a
plan has a funding credit, which is a complex idea, but it can
date back to contributions that were made years and years
earlier, even though the plan now is seriously underfunded,
those credits can actually substantially reduce the
contributions you would want those plans to make.
But there are--generally speaking, we agree with much of
what the PBGC has said in earlier testimony. We think that the
variable premium and the deficit reduction contribution need
some fixing.
Senator Fitzgerald. Mr. Parks, I know you mentioned in your
opening statement enhancing the tax deductibility of, I guess
you might call them excess pension contributions and the tax
deductibility of which was reduced in the 1990's. Do you have
any specific recommendations in that regard? A company, I
gather, cannot go over its required contribution before it
starts incurring tax penalties?
Mr. Parks. That is correct, and as a matter of fact, they
may even be compelled to pay an excise tax if they contribute
in excess of the maximum deductible contributions.
Senator Fitzgerald. Why would we impose an excise tax on
somebody doing it? I gather there were problems with small
companies maybe dumping money into the executive pension fund,
but can't we target a law better? Mr. Iwry, you were at the
Treasury Department at the time.
Mr. Iwry. I was, Mr. Chairman, and I think that you may be
referring principally to the so-called full funding limitation,
which was imposed more stringently in 1987. Has just been
phased down and will be repealed 3\1/2\ months from now.
Now, as you might expect from having grappled with the
statute before this hearing, there is not just one full-funding
limitation, there are two, but the one that had presented the
most problems or aroused the most concern on the part of plan
sponsors trying to fund fully in good times has been slated for
repeal and will go out of existence on January 1. Now, I am not
suggesting that that necessarily is enough and that we ought to
stop there, but----
Senator Fitzgerald. There are other full-funding
limitations elsewhere in the statute.
Mr. Iwry. Yes, and they serve a reasonable purpose. The
question is whether they ought to be fine-tuned.
Senator Fitzgerald. It sounds like the whole statute needs
to be dramatically simplified, and maybe we should have some
actuaries working on this as opposed to politicians.
[Laughter.]
Mr. Stein. There is actually a very interesting article in
the recent edition of your magazine, Contingencies, by an
actuary called Jeremy Gold, who is sort of an iconoclast, but
he has suggested a very simple way of funding plans, which is
you basically have a corridor based on current liabilities and
you can go so much below it and so much above it, and if you
get too far below, you have to start making immediate
contributions to bring it up to whatever the minimum target is,
whatever the floor is. He says, basically, just establish a
floor and ceiling based on the liabilities.
Senator Fitzgerald. But your definition of what your
current liabilities are is very important----
Mr. Stein. That would have to be worked out----
Senator Fitzgerald [continuing]. And I gather there is a
lot of mischief in that.
Mr. Stein. That would have to be worked out and it would be
a miracle if you could work it out in a way that avoided
complexity.
Senator Fitzgerald. Now, I am not going to go on much
longer. The afternoon has been dragging on. You all have been
terrific witnesses. But I know, Ms. Cissna and Mr. O'Flinn, you
were--I think Mr. O'Flinn specifically--you made a reference to
it is really only about 2 percent of the companies that are
financially weak and have really badly funded pension plans.
That would mean that most companies with defined benefit plans
have managed them responsibly, they are in pretty good fiscal
shape, and the trouble we are in is resulting from a very small
number of bad actors.
I would think, therefore, that it would be in the interest
of the 98 percent of companies that are strong and are good
actors to get really tough on the ones who aren't, because
ultimately, the well-funded plans may have to pick up the tab
for the poorly-funded plans in terms of increased insurance
premiums to the PBGC.
Mr. O'Flinn. That is a fair characterization, Mr. Chairman.
I think in terms of disclosure, something along the lines that
Mr. Iwry was describing earlier, we have much less concern with
than a broad-brush approach that puts out data that may be
misinterpreted and is really irrelevant to a member of the 98
percent.
Senator Fitzgerald. But a company that has a very well
funded pension plan, even on a termination basis, I would think
they might even want that information out, because then
analysts could see, and their employees could see that it is
really well funded. Maybe they wouldn't want their workers
pressing for more pension sweeteners, but to some extent, that
would help some of the companies. It might remove some doubt
about whether a company's pension plan has a severe problem.
Mr. O'Flinn. I think that many companies have early
retirement benefits to service a very small portion of the
population which can be expected to leave before what you might
call expected retirement, and that is their primary purpose. To
do evaluation which basically assumes that many more people--
virtually all the people are going to use those who qualify for
them at the time of the valuation is--I don't know what you
would call it, a red herring, something that would involve
hours of explanation to people who, frankly, have enough
trouble understanding the current liability test now. I am
speaking from the employees' point of view.
To explain that there is a government-required number,
that, on its face, would raise concern because I don't believe
very many companies are funded, well funded on a termination
basis, at least the large companies in our organization who
maintain robust early retirement benefits. They are funded for
how they are expected to use them, but they are not funded on a
termination basis.
Ms. Cissna. Nor do they anticipate terminating.
Mr. O'Flinn. Exactly. They are funded for how they are
expected to occur, with the advice of their actuaries and
accountants who are monitoring their situation.
Ms. Cissna. And, Mr. Chairman, if I could add, I think it
is also--I think you will agree with me on this, I don't know,
but fairly short sighted to assume that the sponsors of
reasonably well-funded plans aren't doing a lot of asset
liability modeling anyway, looking at when those assets are
going to be required, what the payment schedules are going to
be. It is not like these things are being ignored completely.
Senator Fitzgerald. Do you think, both Ms. Cissna and Mr.
O'Flinn, that your members object if there were a requirement
that plans whose funding falls below a certain level be frozen,
that they couldn't sweeten benefits anymore, all to shelter the
PBGC from further risk?
Ms. Cissna. Well, freezing is a tough word. I mean,
freezing is a lot different also than not enhancing. If you are
going to tell my participants that they can't earn another
penny after today----
Senator Fitzgerald. Well, if the plan is----
Ms. Cissna [continuing]. Because on a termination basis,
which the plan does not intend to do, it looks somewhat
unfunded.
Senator Fitzgerald. Well, I think the administration's
proposal is if you are not 50 percent funded on a current
liability basis, then you can't sweeten your pensions at all.
To me, it should be a much stricter requirement than that. I
would think if you weren't 100 percent funded, that you
shouldn't be able to sweeten your benefits. I think that would
protect the other companies, the 90 percent that are healthy
and financially responsible with their plans.
Mr. O'Flinn. We do think that work needs to be done on what
liability the PBGC takes over, particularly recently created
liability. And, of course, the law has some relief in that
regard already. But remember, Mr. Chairman, there are new
companies that start pension plans that are maybe far away from
100 percent funding. So you would have to take into
consideration that category, as well. I agree, a well-
established plan would aim for probably somewhat higher than
100 percent funding on an ongoing basis, but it may take a
while to get there.
Senator Fitzgerald. Professor Stein.
Mr. Stein. Yes. There is an alternative path which some
people have suggested, which is if you have a seriously
underfunded plan, to try and develop rules that will allow, as
Kathy said, the regular benefits to continue but to ensure that
the deficit doesn't grow, that is, all new benefits would have
to be immediately funded and the deficit can't become any
worse, that is, you amortize the deficit over some period of
time, perhaps an extended period of time, which would at least
say to the PBGC, this plan can continue. We don't have to
prematurely terminate it. Our situation, it might not get
better, but at least it won't get worse.
Senator Fitzgerald. Mr. Iwry.
Mr. Iwry. Yes, Mr. Chairman. I agree. We have a 5-year
phase-in now, as you know, of the PBGC's guarantee, so that
benefits added shortly before termination are not fully
guaranteed. Now, that may not go far enough toward protecting
the PBGC, but I think the administration's proposal to not only
prevent sweetening of benefits, as you say, but to prevent
continuation of the existing level of benefits--that is, their
proposal to require freezing of additional accruals and
suspension of lump-sum payments in excess of $5,000 per
person--I think those proposals are probably too draconian,
that we ought to be looking at accelerated funding of what are
really new promises.
And again, I would suggest taking into account the cost of
living updating that occurs automatically in the non-union
plans but has to be negotiated periodically in the union plans,
putting that into the mix when we think about what the policy
ought to be with respect to sweeteners. To what extent is that
meeting reasonable expectations of the workers, who, after all,
don't control the funding of their sponsors' plans and, of
course, don't control the financial condition of their
sponsors.
Senator Fitzgerald. We are going to close shortly, and I
want to ask one final question. As all of you know, General
Motors has taken some dramatic actions to strengthen its
pension funds, going to the capital markets to borrow, I
gather, $15 billion and having the corporation assume the debt
and putting the proceeds in the pension fund. Would anybody
care to comment on this strategy and whether other companies
should be encouraged to follow?
Mr. Stein. It has been suggested that there are some
accounting benefits, given the way the accounting treatment of
pension funding works, that by putting the money in the plan
and then assuming a higher rate of return, General Motors will
actually be able to have some extra earnings added to its
annual operating earnings. But frankly, I would rather see the
money in the plan than not in the plan, so whatever its
motives----
Senator Fitzgerald. Do you know what percentage funded they
are now?
Mr. Stein. No.
Senator Fitzgerald. OK. They had $15 billion that went a
long way, I think, in any case.
Mr. Stein. Yes, but if their motives are impure, the
effects are very good, so God bless them.
Senator Fitzgerald. OK. [Laughter.]
Well, thank you all very much. You all have been excellent
witnesses and we appreciate your time and attention on a
complex matter. Thank you for being here. We will keep the
record open until the close of business tomorrow, if you would
like to have any further statements put in the record or if
Senators would like to have further statements put in the
record.
Thank you all very much. This hearing is adjourned.
[Whereupon, at 5:01 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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