[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
PBGC'S UNFUNDED PENSION LIABILITIES:
WILL TAXPAYERS HAVE TO PAY THE BILL?
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, JUNE 9, 2005
__________
Serial No. 109-7
__________
Printed for the use of the Committee on the Budget
Available on the Internet: http://www.access.gpo.gov/congress/house/
house04.html
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COMMITTEE ON THE BUDGET
JIM NUSSLE, Iowa, Chairman
JIM RYUN, Kansas JOHN M. SPRATT, Jr., South
ANDER CRENSHAW, Florida Carolina,
ADAM H. PUTNAM, Florida Ranking Minority Member
ROGER F. WICKER, Mississippi DENNIS MOORE, Kansas
KENNY C. HULSHOF, Missouri RICHARD E. NEAL, Massachusetts
JO BONNER, Alabama ROSA L. DeLAURO, Connecticut
SCOTT GARRETT, New Jersey CHET EDWARDS, Texas
J. GRESHAM BARRETT, South Carolina HAROLD E. FORD, Jr., Tennessee
THADDEUS G. McCOTTER, Michigan LOIS CAPPS, California
MARIO DIAZ-BALART, Florida BRIAN BAIRD, Washington
JEB HENSARLING, Texas JIM COOPER, Tennessee
ILEANA ROS-LEHTINEN, Florida ARTUR DAVIS, Alabama
DANIEL E. LUNGREN, California WILLIAM J. JEFFERSON, Louisiana
PETE SESSIONS, Texas THOMAS H. ALLEN, Maine
PAUL RYAN, Wisconsin ED CASE, Hawaii
MICHAEL K. SIMPSON, Idaho CYNTHIA McKINNEY, Georgia
JEB BRADLEY, New Hampshire HENRY CUELLAR, Texas
PATRICK T. McHENRY, North Carolina ALLYSON Y. SCHWARTZ, Pennsylvania
CONNIE MACK, Florida RON KIND, Wisconsin
K. MICHAEL CONAWAY, Texas
CHRIS CHOCOLA, Indiana
Professional Staff
James T. Bates, Chief of Staff
Thomas S. Kahn, Minority Staff Director and Chief Counsel
C O N T E N T S
Page
Hearing held in Washington, DC, June 9, 2005..................... 1
Statement of:
Hon. David M. Walker, Comptroller General of the United
States..................................................... 6
Hon. Douglas Holtz-Eakin, Director, Congressional Budget
Office..................................................... 22
Prepared statement of:
Mr. Walker................................................... 7
Mr. Holtz-Eakin.............................................. 26
PBGC'S UNFUNDED PENSION LIABILITIES: WILL TAXPAYERS HAVE TO PAY THE
BILL?
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THURSDAY, JUNE 9, 2005
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 9:31, in room 210,
Cannon House Office Building, Hon. Jim Nussle (chairman of the
committee), presiding.
Members present: Representatives Nussle, Ryan, Conaway,
Chocola, Spratt, Moore, Neal, Edwards, Cooper, Davis, Case, and
Schwartz.
Chairman Nussle. The budget hearing will come to order.
I understand that there are members who are still trying to
get to the Hill as a result of the early morning fire at the
Rayburn Building, but we will begin the hearing.
Our witnesses have time constraints. I know members will
have time constraints as a result of votes on the floor being
done today, approximately 1 o'clock.
This is a full committee hearing on PBGC's [Pension Benefit
Guaranty Corporation] unfunded pension liabilities, and we have
an opportunity today to hear from two expert witnesses who have
testified often before our committee. We welcome back: David
Walker, the Comptroller General, and Douglas Holtz-Eakin, the
Director of the Congressional Budget Office [CBO].
Good morning, and welcome to this hearing.
I understand that you, General Walker, have a plane to
catch, I believe at 11:30 a.m. So we will try and get into this
as quickly as possible. And I ask members to be as succinct as
possible.
The focus of today's hearing is really three-fold.
First, to look at the magnitude of the problems facing our
Nation's system of pension benefits and the implications of
those problems, not only for future pensioners, but also for
taxpayers as a whole.
Second, to discuss how the Federal budget might better
account for unfunded obligations or the enormous projected
shortfalls of our Nation's pension guarantee system.
Third, to review some of the areas likely in need of
reform. And I am not talking about any specific proposal today
that I am offering or that I would assume any other members are
offering, but rather what key areas we need to look at or
address if we are going to try and tackle this.
I think most people of working age have a pretty good grasp
of what the pension plans are all about. And while maybe not to
the extent of my father's generation, many of us in their 40's
and 50's who are planning for or getting ready, near
retirement, are counting on at least pensions to be a portion
of that retirement.
So I don't have to tell anybody why the guarantee of
promised pension benefits is a very critical issue, for not
only our Nation's workers and retirees, but we will find out
today, as well for our taxpayers.
The subject has been gaining quite a bit of steam in the
press in the last few weeks. I am not sure that there is a
clear understanding of why pension benefits are facing such a
large shortfall in the future as I read the press accounts. So
I will just give a quick overview from the way I see it, and
this is in part why we have a hearing today.
For about the last 30 years, the Employee Retirement Income
Security Act mandated companies that offered employee defined
benefit pension plans to obtain insurance for these plans
through the PBGC Corporation, or the Pension Benefit Guaranty
Corporation.
The intent was to ensure that the promised retirement
benefits of U.S. workers would be maintained, even if the
company became insolvent or for some reason the pension plan
failed.
So in a nutshell, if the pension plan collapsed, the PBGC
would take over, pool its current assets with those of other
failed plans, then use the resources, coupled with premiums
from other participating companies that are purchasing the
insurance, to pay for benefits.
Now in theory, the PBGC was supposed to be completely self-
financing. The assets it assumed when it took over the failed
pension plan, combined with the insurance premiums that were
paid to the corporation by the participating companies, were
supposed to be adequate to supply the resources to satisfy the
pension promises.
But as we are discovering, and as most of us here know,
that is not what has been happening. According to PBGC, its
current total assets fall short about $23 billion of the amount
needed to pay all of the benefits currently promised to pension
beneficiaries.
As equity values declined during the recession of the 2000-
2001 time period, several major pension benefit plans were
terminated and turned over to PBGC with substantial
underfunding, including the LTV Corporation, Bethlehem Steel
and the now-terminated United Airlines plan.
Because these plans are large and also substantially
underfunded, they have created a significant shortfall for the
PBGC. And according to the Congressional Budget Office, that is
not even half the story we are going to hear today from their
soon-to-be-released report that I think is going to be part of
the testimony today. Just to peek at that a moment, we
understand that CBO is going to estimate that it could rise
another $75 billion, or the difference between projected future
obligations of the PBGC and the agency's projected resources.
All told, PBGC is expected to run about $100 billion short
of the resources needed to pay promised benefits from failed
private pension plans, according to the report, as I understand
it. To make matters worse, the Center on Federal Financial
Institutions, which tracks pensions, tells us that on the
current path, all PBGC assets will be exhausted, completely
gone, by 2021, just 15 years from now.
So where does that leave us? Well, under the current
scenario, if and when PBGC's assets fall short, the choice is
really one of two right now. Either for pension holders to lose
about $100 billion in promised retired benefits, or for the
taxpayers to get slapped with about a $100 billion bill for
failed private pension plans.
In the realm of fairness, I don't think either one of those
choices is going to be very palatable, and in the realm of
politics, probably very difficult. So I think we need to talk
about how we are going to solve this problem, and if you look
at how the budget fails to recognize the problem, it even gets
worse.
First, we have a problem accounting for the balances in
PBGC. The current budget figures do not reflect the true cost
to the Government of taking over failed plans. It only reflects
the agency's annual cash flow, which in 2004 showed that the
agency had a net surplus of $247 million, even though it was
carrying $23 billion in unfunded liabilities from pension plans
it had already taken over. And that doesn't include the
unfunded liabilities from pension plans it will likely take
over, which again, according to CBO, would be as much as about
$75 billion.
The PBGC's so-called unfunded obligations are a prime
example of similar problems in other large government programs,
especially insurance programs.
Most of us recall the enormous tax burden that came to us
in the 1980s when the savings and loan debacle occurred, and
when savings and loans collapsed. Due in large part to
insufficient accounting, we missed the warning signs on that
one, and it led to a major fiscal crisis. Policy experts have
long advocated finding ways to report these obligations
regularly, and if possible, to budget for them.
Back in 1997, Congressman Cardin and I began an effort to
have the budget reflect actual costs of government liabilities,
including likely risks. So I am especially looking forward to
the discussion today, particularly in light of the warnings
that we have received, looking at the shortfalls for PBGC. We
need to talk about accrual accounting. There are many members
who are leaders in that regard and have bills and legislation
and ideas.
One final note: I am sure that this is a good area for
finger pointing. If that is the case, not only today and in
coming months, as to who is to blame for the state of the
Nation's pension systems, but I think we need to keep a couple
of things in mind.
One is that defined benefit plans and the PBGC were created
in a different time, really for a different economy. American
companies were competing with other American companies, who
were also figuring pension benefits into their bottom line.
Today, companies are competing in a global marketplace,
which is much different than when these plans and PBGC were
developed. As of today, many newly industrialized nations have
little or no employee benefits to add to their bottom line.
These same companies are also competing with new American
companies, who don't offer defined benefit pensions, but rather
defined contribution plans, which are less expensive and don't
burden the company with the risk of those plans. So while
defined benefit pension plans are becoming less and less common
in newer companies and nearly nonexistent overseas, companies
who still offer these plans can find themselves at a
substantial financial disadvantage to those companies who
don't.
The second point I would make is that the same demographic
changes that are putting enormous stress on Social Security,
such as the static workpool, the aging population, the longer
life expectancies and significantly higher wages and thus
higher benefits are causing some of the imbalances in the
pension system.
Point three, and perhaps most important, would be that PBGC
was set to be self-financing, yet it cannot achieve that goal
if a number of large, severely underfunded pension plans fail.
A plan underfunding destabilizes the whole system, and yet the
rules we have created to prevent it are complicated,
ineffective, and too often easily evaded.
All of that said, for the loyal workers who were promised
benefits and are counting on those benefits to help fund their
retirement, that explanation provides exactly no relief. They
expect, and rightly so, that the benefits that are the ones
they were promised are received. And the American taxpayers are
the ones who stand to be the biggest losers in all of this,
simply through default, I will guess that bailing out private
pension plans is not high on their priority list of how they
would like to have their tax dollars spent.
So no question, I can't imagine anyone that can find an
easy answer to correct this problem. It is going to be a
difficult balancing act, but nevertheless, we have to start
understanding this problem and its fiscal consequences for our
economy and for our budget immediately.
I would like to thank the leadership of my friend and
colleague Mr. Spratt, who requested this hearing. I was eager
to join him in holding the hearing, but he requested it. I
appreciate his leadership in coming forward and asking that we
hold this very important hearing today. And with that, I would
turn to him for any comments he would like to make.
Mr. Spratt. Mr. Chairman, thank you very much, first of all
for holding the hearing as I requested and also for your
opening statement, because I think you have stated the problems
squarely that we have to confront.
I also want to thank our two witnesses, Comptroller General
David Walker and CBO Director Douglas Holtz-Eakin. They are
regulars at our hearings, but we always are the beneficiaries
for their wisdom and advice and their analytical input to the
decisions we have to make.
Rather than repeat or plow over ground that the chairman
just covered, let me simply say that we clearly have more
things to do on the Budget Committee than just priorities about
spending and revenues. We need to be one of the committees in
Congress that looks forward to problems that are not yet fully
fleshed out and try to bring timely attention to them so that
they can be resolved earlier, at a lesser cost and with better
solutions than we do typically when we leave things to the
crisis stage to be addressed.
And PBGC, the Pension Benefit Guaranty Corporation, falls
squarely in that realm.
We have the largest cash budget in the world, the Federal
budget. As a consequence, there are a number of accrual that we
simply don't recognize, don't accommodate, don't even include,
except in appendices nobody ever reads, to our budget.
So one of the questions that we have to ask ourselves today
and in future hearings of this kind is with our cash budget,
our non-accrual budget, how do we nevertheless make budget
issues like the accumulation of accrued liabilities for the
pensions of the United States, the defined benefit pensions,
something that is annually considered, particularly when the
system is not adequately assessing the risk, underfunding, the
health of corporate sponsors.
One of the problems clearly we have here that you can
discern just from a superficial reading of the testimony of the
two witnesses that is about to be presented, is that there are
so many factors that we don't yet have a good handle for.
The statement of the shortfall in the Pension Guaranty
trust fund may relate to the fact that a financially healthy
and very able corporation has simply not funded adequately its
pension plan, but nevertheless, it is a corporate parent or
sponsor of that plan, stands liable for the assets it may not
reflect any kind of necessary liability to the Government.
Secondly, the plan may be invested in gilt-edge assets, or
it may be invested in assets whose net realizable value cannot
be achieved with the liquidation of those assets.
There are a whole host of problems like this what we simply
haven't resolved. We have coasted along with this program for a
long time, and now we have some hard questions to ask:
How do you adjust the premiums to reflect the financial and
economic reality? How do you baseline those premiums so that
when we do the budget every year, we can tell the policy
changes actually affect or improve or worsen the baseline,
which the CBO is trying to develop now.
But Dr. Holtz-Eakin, as I read your testimony, I think you
would describe it as a work in progress. You aren't really
through with it, which is an illustration of how difficult it
is to get your hands around this problem.
As difficult as it may be, politically and simply
institutionally, to address the proper response to is, we need
to be paying close attention to it and bending every effort to
get this done, not only to get it done, but done right, so that
we can put this plan on a firm basis for the future.
With that, let me end, and I will welcome again our two
witnesses and say we look forward to your testimony today and
your help in the future as we address this problem.
Chairman Nussle. Thank you, Mr. Spratt.
And my understanding is that, General Walker, you will go
first with your testimony.
Welcome back to the committee. Thank you for your
leadership in not only bringing this problem to our attention,
but also in giving us ideas of solutions. We are pleased to
receive your testimony.
Your written testimony will be made part of the record. And
I would also ask unanimous consent that all members have the
opportunity to place an opening statement in the record.
Mr. Walker.
STATEMENT OF HON. DAVID M. WALKER, COMPTROLLER GENERAL OF THE
UNITED STATES
Mr. Walker. Thank you, Mr. Chairman, Ranking Member Spratt,
and other members of the House Budget Committee. It is a
pleasure to be back before you, this time to talk about the
Pension Benefit Guaranty Corporation and related issues.
In the interest of full and fair disclosure, let me remind
the members that in a prior life, before I was Comptroller
General of the United States, I was a head of the PBGC,
Assistant Secretary of Labor for Pensions and Health, and a
Trustee of Social Security and Medicare. I think that all of
those are relevant to today's topic.
I would respectfully suggest that what we have before us is
a subset of a much greater challenge, namely the Pension
Benefit Guaranty Corporation is a subset of a broader
challenge, which is the state of retirement security in the
United States, which includes Social Security, Medicare,
private pensions, retiree health, long-term care, and that that
is a subset of the broader fiscal challenge that the United
States faces because of known demographic trends, rising health
care costs and revenues that mismatch promises that have made.
So it is very appropriate and important for this committee
to have this hearing to understand how this issue fits within
the broader context.
Unfortunately, while this is a significant challenge, it is
one of the less material challenges, as you will see. With the
aid of your technology, I would like to just show you a few
graphics to make several points that I think might be helpful.
I would note that each member should have received this
morning this report on a forum that we recently held at GAO
(Government Accountability Office) on PBGC and the defined
benefit pension system. This report is being released this
morning and has been posted to our website.
The first slide, please.
You have seen this before. This is the disembodiment chart.
This is the U.S. budget in the long term. Due to known
demographic trends, rising health care costs and lower revenues
as a percentage of the economy, depending upon what assumptions
you use--in this particular case, that discretionary spending
grows by the rate of the economy, that all tax cuts are made
permanent and that the Social Security and Medicare trustees'
estimates of the costs of those programs under the intermediate
assumptions are realistic--you can see this is a very sour
outlook and an unacceptable path for the only superpower on
Earth.
Next, please.
This represents the PBGC. The left bar is assets. The right
bar is liabilities. The line represents their accumulated
deficit.
They have gone from a $9.7 billion surplus in 2000 to a
$23.3 billion accumulated deficit in 2004. I could show you
another graphic which would look very similar, which is the
Federal budget.
Next.
This represents the state of defined benefit pension plans,
based upon GAO's recently issued report. The bottom line is
that the most recent data that was available to the Government
was 2002. This is 2005; 2003 data is just now becoming
available. That is a problem in and of itself.
Based upon the trends from 1995 to 2002, the bottom line
with this chart is that the overall state of funding in the
defined benefit system deteriorated during that period of time.
Next, please.
This chart shows that very few cash contributions were made
by the 100 largest plans in the system during the period 1995-
2002, in part because of flaws in the current funding rules.
There are fundamental flaws in the current funding rules.
People are not required to deliver on their promises. People
are making promises that they realistically cannot keep. People
are doing what the law minimally requires, versus what is the
right thing to do.
As we all know, the law represents the minimum standard of
acceptable behavior. Hopefully, people should do what is right.
Unfortunately in this case, many are not.
Next, please.
This represents how the state of underfunding in the entire
defined benefit system has deteriorated dramatically since
2000. The purple represents the possible losses to the PBGC, in
other words, entities that are deemed to be high risk as it
relates to PBGC.
You can see that the PBGC's exposure has increased
significantly. At the end of 2004, it represented about $100
billion. That is in addition to the $23.3 billion accumulated
deficit.
Next, please.
This is an example of the problem with the funding rules.
Two of the largest losses in PBGC's history, Bethlehem Steel
and LTV, and I am going through the period 2002, because that
is the data that we had. These represented two of the largest
losses in the history of the PBGC insurance system. These
companies made no cash contributions in the last years of their
life.
And guess what: They weren't required to, based upon the
law. In fact, they had significant credits available to them,
such that at least one of these plans wouldn't have had to make
contributions the next year and possibly thereafter. At the
same time, on termination they were only funded at about 50
percent of the level of accrued benefits.
If that doesn't illustrate that the system is broken, I
don't know what would.
I think that is it, I believe, with regard to the graphics.
Thank you very much, and I appreciate the opportunity to be
with you. I look forward to having the opportunity to answer
any questions that you may have.
[The prepared statement of David Walker follows:]
Prepared Statement of Hon. David M. Walker, Comptroller General of the
United States
Mr. Chairman and members of the committee, I am pleased to be here
today to discuss the problems and long-term challenges facing the
defined benefit (DB) pension system, the Pension Benefit Guaranty
Corporation (PBGC), the retirement security of workers and retirees
covered by DB plans, and American taxpayers. In particular, I will
discuss the factors contributing to those problems and suggest elements
of the comprehensive reform necessary to address them.\1\ As I have
noted before, these problems are a subset of the broader challenges
facing the Federal Government and our nation's retirement income
system.\2\ These programs, which include Social Security, Medicare, and
Medicaid, represent large, growing, and unsustainable claims on the
Federal budget because America's population is aging, life expectancies
are increasing, workforce growth is slowing, and health care costs are
rising.
The long-term effect of Federal retirement programs on the budget
is so significant that neither slowing the growth of discretionary
spending nor allowing tax cuts to expire--nor both options combined--
would by themselves eliminate our long-term fiscal imbalance (see fig.
1). Therefore, as we discussed in our 21st Century Challenges
report,\3\ tough choices need to be made about the appropriate role and
size of the Federal Government--and how to finance that government--and
how to bring the panoply of Federal policies, programs, functions and
activities into line with the realities of today's world and tomorrow's
challenges. More specifically to Federal retirement policy, we need to
make choices about how to promote current and long-term economic
security in retirement. In that latter context, comprehensively
considering our citizens' needs for income, health care, and long-term
care is important.
From our nation's overall fiscal perspective, continuing on our
current unsustainable fiscal path will gradually erode, if not suddenly
damage, our economy, our standard of living, and ultimately our
national security.
Therefore, we must fundamentally reexamine major spending and tax
policies and priorities in an effort to recapture our fiscal
flexibility and ensure that our programs and priorities respond to
emerging security, social, economic and environmental changes and
challenges.
Figure 1: Composition of Spending as a Share of GDP Assuming
Discretionary Spending Grows With GDP After 2005 and All Expiring Tax
Provisions Are Extended
Notes: Although expiring tax provisions are extended, revenue as a
share of gross domestic product (GDP) increases through 2015 due to (1)
real bracket creep, (2) more taxpayers becoming subject to the
alternative minimum tax, and (3) increased revenue from tax-deferred
retirement accounts. After 2015, revenue as a share of GDP is held
constant.
PBGC is an excellent example of the need for Congress to reconsider
the role of government programs, in general, and Federal retirement
programs, in particular, in light of past changes and 21st century
challenges. In 1974, Congress passed the Employee Retirement Income
Security Act (ERISA) to respond to trends and challenges that existed
at that time.\4\ Among other things, ERISA established PBGC to pay the
pension benefits of defined benefit plan participants, subject to
certain limits, in the event that an employer could not.\5\ When ERISA
was enacted, defined benefit pension plans were the most common form of
employer-sponsored private pension and were growing both in number of
plans and in number of participants. Today, defined benefit pensions
cover an ever-decreasing percentage of the U.S. labor force, a fact
that raises questions about Federal policy on pensions in general, and
defined benefit plans and the PBGC, in particular.
I would now like to outline the challenges facing the defined
benefit pension system and PBGC and suggest a framework for evaluating
potential policy responses. In summary, a combination of recent events,
long-term structural problems, and weaknesses in the legal framework
governing pensions has left PBGC with a significant long-term deficit
and many large plans badly underfunded. Lower interest rates and equity
prices since 2000 have combined to significantly increase pension
underfunding through an increase in the present value of pension
liabilities, and decreases in the value of pension plan assets.
Meanwhile, intense cost competition as a result of globalization and
deregulation has led to bankruptcies of plan sponsors in key industries
like steel and airlines, and is exposing PBGC to the risk of
significant future losses in these and other industries. This
competitive restructuring has occurred simultaneously with a long-term
decline in defined benefit plan participation that threatens PBGC's
revenue base. In addition, the basic legal framework governing pension
insurance and plan funding has failed to safeguard the benefit security
of American workers and retirees and the PBGC's financial condition.
Too many companies are making pension promises that they are not
required to deliver on, in part because of perverse incentives and
``put options'' created under the current pension insurance system.
PBGC's current premium structure does not properly reflect the
risks to its insurance program and facilitates moral hazard by plan
sponsors. Further, as we have shown in a recent report, current pension
funding rules have not provided sufficient incentives, transparency,
and accountability mechanisms for plan sponsors to properly fund their
benefit obligations and deliver on their promises.\6\ As a result,
bankrupt plan sponsors, acting rationally and within the rules, have
transferred the obligations of their large and significantly
underfunded plans to PBGC. These weaknesses in the legal framework
contribute to and are exacerbated by a lack of transparent information
that makes it difficult for interested stakeholders to understand the
true financial condition of and risk associated with selected pension
plans.
Given pension plans' crucial significance to our nation's
retirement security net, it is useful to compare the challenges facing
PBGC's insurance program and Social Security. Both systems require
meaningful, comprehensive reform that restores solvency, assures
sustainability, and protects the benefits of participants. Similar to
that of Social Security, PBGC's current condition does not represent a
crisis, though delaying reform will result in serious adverse
consequences for individuals, the Federal budget, and our economy.
Furthermore, like Social Security, PBGC has plenty of cash on hand
today to pay benefits to participants in the short term, but it faces
large and growing unfunded obligations and escalating cash flow
deficits in the future.
The termination of United Airlines' defined benefit pension plans
is just the latest in a recent series of large, underfunded plans taken
over by PBGC, and will not be the last. In July 2003, GAO designated
PBGC's single-employer insurance program as ``high-risk,'' given its
deteriorating financial condition and long-term vulnerabilities.\7\ At
the end of fiscal year 2004, PBGC estimated that it was exposed to
almost $100 billion of underfunding in plans sponsored by companies
with credit ratings below investment grade. Though smaller in scale
than Social Security, Medicare, and Medicaid, PBGC's deficit threatens
to worsen our government's long-term fiscal position.\8\ While PBGC is
not explicitly backed by the full faith and credit of the U.S.
Government,\9\ policymakers would undoubtedly face intense pressure to
provide PBGC the resources to continue paying earned pension benefits
to millions of retirees if PBGC were to become insolvent.
In light of the intrinsic problems facing the defined benefit
system, meaningful and comprehensive reform will be needed to ensure
that workers and retirees receive the benefits promised to them and to
secure PBGC's financial future. At this time, the Administration,
Members of Congress, and others have proposed reforms that seek to
address many of the problems facing PBGC and the defined benefit
system. This is a promising development that can be a critical first
step in addressing part of the long-term fiscal problems facing this
country.
background
Before enactment of the Employee Retirement Income Security Act of
1974 (ERISA), few rules governed the funding of defined benefit pension
plans, and participants had no guarantees that they would receive their
promised benefits. Among other things, ERISA created the PBGC to
protect the benefits of plan participants in the event that plan
sponsors could not meet the benefit obligations under their plans.
ERISA also established rules for funding defined benefit pension plans,
instituted pension insurance premiums, promulgated certain fiduciary
rules, and developed annual reporting requirements. When a plan is
terminated with insufficient assets to pay its guaranteed benefits,
PBGC takes over the plan and assumes responsibility for paying benefits
to participants. According to PBGC's 2004 annual report, PBGC provides
insurance protection for over 29,000 single-employer pension plans,
which cover 34.6 million workers, retirees, and their
beneficiaries.\10\
PBGC receives no direct Federal tax dollars to support the single-
employer pension insurance program. Instead, the program receives the
assets of terminated underfunded plans and any of the sponsor's assets
that PBGC recovers during bankruptcy proceedings.\11\ PBGC finances the
unfunded liabilities of terminated plans with premiums paid by plan
sponsors and income earned from the investment of program assets.
Premiums have two components: a per participant charge paid by all
sponsors (currently $19 per participant), and a variable-rate premium
that some underfunded plans pay based on the level of unfunded
benefits.\12\
The single-employer program has had an accumulated deficit--that
is, program assets have been less than the present value of benefits
and other obligations--for much of its existence. (See fig. 2.) In
fiscal year 1996, the program had its first accumulated surplus, and by
fiscal year 2000, the accumulated surplus had increased to about $10
billion, in 2002 dollars. However, the program's finances reversed
direction in 2001, and at the end of fiscal year 2002, its accumulated
deficit was about $3.6 billion. In fiscal year 2004, the single-
employer program incurred a net loss of $12.1 billion, and its
accumulated deficit increased to $23.3 billion, up from $11.2 billion a
year earlier. Furthermore, PBGC estimated that total underfunding in
single-employer plans exceeded $450 billion, as of the end of fiscal
year 2004.
Figure 2: Assets, Liabilities, and Net Financial Position of PBGC's
Single-Employer Insurance Program
In defined benefit plans, formulas set by the employer determine
employee benefits. DB plan formulas vary widely, but benefits are
frequently based on participant earnings and years of service, and
traditionally paid upon retirement as a lifetime annuity, or periodic
payments until death. Because DB plans promise to make payments in the
future, and because tax-qualified DB plans must be funded, employers
must use present value calculations to estimate the current value of
promised benefits.\13\ The calculations require making assumptions
about factors that affect the amount and timing of benefit payments,
such as an employee's retirement age and expected mortality, and about
the expected return on plan assets, expressed in the form of an
interest rate. The present value of accrued benefits calculated using
mandated assumptions is known as a plan's current liability. Current
liability provides an estimate of the amount of assets a plan needs
today to pay for accrued benefits.
ERISA and the Internal Revenue Code (IRC) prescribe rules regarding
the assumptions that sponsors must use to measure plan liabilities and
assets. While different assumptions will change a plan's reported
assets and liabilities, sponsors eventually must pay the amount of
benefits promised; if the assumptions used to compute current liability
differ from the plan's actual experience, current liability will differ
from the amount of assets actually needed to pay benefits.\14\
Funding rules generally presume that a pension plan and its sponsor
are ongoing entities, and plans do not necessarily have to maintain an
asset level equal to current liabilities every year. However, the
funding rules include certain mechanisms that are intended to keep
plans from becoming too underfunded. One such mechanism is the
additional funding charge (AFC), which applies to plans with more than
100 participants.\15\ The AFC requires plan sponsors to make additional
contributions to plans that fall below a prescribed funding level. With
some exceptions, plans with reported asset values below 90 percent of
current liabilities are affected by the AFC rules.
pbgc's problems stem from recent events, long-term structural trends,
and weaknesses in the legal framework governing db pensions
A combination of recent events, long-term structural problems, and
weaknesses in the legal framework governing the DB system has left PBGC
with a significant long-term deficit and many large plans badly
underfunded. Lower interest rates and equity prices since 2000 have
combined to significantly increase pension underfunding through an
increase in the present value of pension liabilities, and decreases in
the value of pension plan assets. Meanwhile, intense cost competition
as a result of globalization and deregulation has led to bankruptcies
of plan sponsors in key industries like steel and airlines, and is
exposing PBGC to the risk of significant future losses in these and
other industries. This competitive restructuring has occurred
simultaneously with a long term decline in defined benefit plan
participation that threatens PBGC's revenue base. In addition, the
basic legal framework governing pension insurance and plan funding has
failed to safeguard the benefit security of American workers and
retirees and the PBGC's financial condition. Too many companies are
making pension promises that they are not required to deliver on, in
part because of perverse incentives and ``put options'' created under
the current pension insurance system.
PBGC's current premium structure does not properly reflect the
risks to its insurance program and facilitates moral hazard by plan
sponsors. Further, current pension funding rules have not provided
sufficient incentives, transparency, and accountability mechanisms for
plan sponsors to properly fund their benefit obligations and deliver on
their promises. As a result, bankrupt plan sponsors, acting rationally
and within the rules, have transferred the obligations of their large
and significantly underfunded plans to PBGC. These weaknesses in the
legal framework contribute to and are exacerbated by a lack of
transparent information that makes it difficult for interested
stakeholders to understand the true financial condition of and risk
associated with selected pension plans.
recent economic factors exacerbated the underfunding of large
terminated plans by bankrupt sponsors
Over the last 5 years, many large pension plans have been adversely
affected by simultaneous declines in broad equity indexes and long-term
interest rates, as well as by the financial difficulties of their plan
sponsors.\16\ Poor investment returns from stock market declines
affected the asset values of pension plans to the extent that plans
invested in stocks. According to the ERISA Industry Committee, assets
in private sector defined benefit plans totaled $2.056 trillion at the
end of 1999, dropped to $1.531 trillion at the end of 2002, and climbed
back to $1.8 trillion by the end of 2004.\17\ Lower equity values since
the end of 1999 have been particularly problematic because interest
rates have also declined and thus increased the present value of plan
liabilities.\18\ Some sponsors of large pension plans that were
terminated were not in sufficiently strong financial condition to meet
their pension funding requirements because of weaknesses in their
primary business activities. Bankruptcies and pension plan terminations
increased around the U.S. economic recession of 2001 and around prior
recessions.\19\
These conditions played a part in increasing the unfunded
liabilities of plans terminated by bankrupt sponsors since 2000. For
example, according to the filing of its annual regulatory report for
pension plans, Bethlehem Steel's plan went from 86 percent funded in
1992 to 97 percent funded in 1999. From 1999 to its plan termination in
December 2002, plan funding fell to less than 50 percent as assets
decreased and liabilities increased and sponsor contributions were not
sufficient to offset the changes.
long-term declines of key industries and in defined benefit pension
coverage have contributed to pbgc's weakening financial condition
Long-term trends in some sectors of the economy and in defined
benefit pension coverage are threatening both PBGC's future solvency
and the economic security in retirement of workers and retirees. PBGC's
risk of inheriting underfunded pensions largely stems from the fact
that more than half of the pension participants it insures are in the
manufacturing and airline sectors, which have been exposed to lower
cost competition because of several factors including globalization and
deregulation.\20\ A potentially exacerbating risk to PBGC is the
cumulative effect of bankruptcy in these industries: if a critical mass
of firms go bankrupt and terminate their underfunded pension plans,
their competitors may also declare bankruptcy to similarly avoid the
cost of funding their plans.
PBGC also faces the possibility of long-term revenue declines from
demographic changes in the population of defined benefit plan
participants and a shrinking number of DB plans. Over the long term, an
aging population of defined benefit plan participants threatens to
reduce PBGC's ability to raise premium revenues as participants die and
are not replaced by enough new participants. The percentage of
participants who are active workers has declined from 78 percent in
1980 to just under 50 percent in 2002. Furthermore, PBGC cannot
effectively diversify its risk from the terminations of plans in
declining economic sectors because companies in other growing
industries have generally not sponsored new defined benefit plans. As
plan sponsors in weak industries go bankrupt and terminate their
pension plans, PBGC not only faces immediate changes in its financial
position from taking over underfunded plans, but also faces losses of
future revenues from these terminated plans.
A related factor eroding PBGC's premium base is the growth of lump-
sum pension distributions. More and more plan participants are exiting
the defined benefit system by taking lump-sum distributions from their
plans. After a lump-sum distribution is paid, the participant is out of
the defined benefit system and the plan sponsor no longer has to
contribute to the pension insurance system on the participant's behalf.
In addition, lump-sum distributions to participants in underfunded
plans can create the effect of a ``run on the bank'' and worsen a
plan's underfunding. In such cases, the plan may terminate without
enough assets to pay full benefits to other participants and PBGC may
incur losses.
The increasing prevalence of lump-sum distributions in defined
benefit plans and the growth of defined contribution plans also raise
significant questions about whether many Americans will enjoy an
economically secure retirement.\21\ Many Americans are at risk of
outliving their retirement assets as life expectancies, health care,
and long-term care costs continue to increase.
legal framework has not encouraged adequate plan funding, contributing
to pbgc's financial difficulties
Existing laws and regulations governing pension funding and
premiums have contributed to PBGC's financial difficulties and exposed
PBGC to greater risks from the companies whose pension plans it
insures. PBGC's current premium structure does not properly reflect the
risks to its insurance program and facilitates moral hazard by plan
sponsors. Further, the pension funding rules, under ERISA and the IRC,
have not ensured that plans have the means to meet their benefit
obligations in the event that plan sponsors run into financial
distress. First, the current rules likely allowed plans to appear
better funded than they actually were, in both good years and bad
years. And even these reported funding levels indicated significant
levels of underfunding in our study of the 100 largest DB plans.\22\
Second, plan sponsors often substituted ``account credits'' for cash
contributions, even as the market value of plan assets may have been in
decline. And third, the AFC, the primary mechanism for improving the
financial condition of poorly funded plans, was ineffective in doing
so. These weaknesses contribute to and are exacerbated by a lack of
transparent information that makes it difficult for plan participants,
investors, and others to have a clear understanding of their plan's
financial condition. As a result, financially weak benefit plan
sponsors, acting rationally and within the current law, have been able
to avoid large contributions to underfunded plans prior to bankruptcy
and plan termination, thus adding to PBGC's current deficit.
pbgc's premium structure does not properly reflect risks to the
insurance program
PBGC's current premium structure does not properly reflect risks to
the insurance program. The current premium structure relies heavily on
flat-rate premiums, which, since they are unrelated to risk, result in
large cost shifting from financially troubled companies with
underfunded plans to healthy companies with well-funded plans. PBGC
also charges plans a variable-rate premium based on the plan's level of
underfunding. However, these premiums do not consider other relevant
risk factors, such as the economic strength of the sponsor, plan asset
investment strategies, the plan's benefit structure, or the plan's
demographic profile. PBGC is currently operated somewhat more on a
social insurance model, since it must cover all eligible plans
regardless of their financial condition or the risks they pose to the
solvency of the insurance program.
In addition to facing firm-specific risk that an individual
underfunded plan may terminate, PBGC faces market risk that a poor
economy may lead to widespread underfunded terminations during the same
period, potentially causing very large losses for PBGC. Similarly, PBGC
may face risk from insuring plans concentrated in vulnerable industries
affected by certain macroeconomic forces such as deregulation and
globalization that have played a role in multiple bankruptcies over a
short time period, as has happened recently in the airline and steel
industries. One study estimates that the overall premiums collected by
PBGC amount to about 50 percent of what a private insurer would charge
because its premiums do not adequately account for these market
risks.\23\ Others note that it would be hard to determine the market-
rate premium for insuring private pension plans because private
insurers would probably refuse to insure poorly funded plans sponsored
by weak companies.
pbgc is subject to moral hazard
Current pension funding and insurance laws create incentives for
financially troubled firms to use PBGC in ways that Congress likely did
not intend when it formed the agency in 1974. At that time, PBGC was
established to pay the pension benefits of participants, subject to
certain limits, in the event that an employer could not. However, since
that time, some firms with underfunded pension plans may have come to
view PBGC coverage as a fallback, or ``put option,'' for financial
assistance. The very presence of PBGC insurance may create certain
perverse incentives that represent what economists call moral hazard--
where struggling plan sponsors may place other financial priorities
above funding up their pension plans because they know PBGC will pay
guaranteed benefits. Firms may even have an incentive to seek Chapter
11 bankruptcy in order to escape their pension obligations. As a
result, once a plan sponsor with an underfunded pension plan
experiences financial difficulty, these moral hazard incentives may
exacerbate the funding shortfall for PBGC.
This moral hazard effect has the potential to escalate, with the
initial bankruptcy of firms with underfunded plans creating a vicious
cycle of bankruptcies and terminations. Firms with onerous pension
obligations and strained finances could see PBGC as a means of shedding
these liabilities, thereby providing these companies with a competitive
advantage over other firms that deliver on their pension commitments.
This would also potentially subject PBGC to a series of terminations of
underfunded plans in the same industry, as we have already seen with
the steel and airlines industries in the past 20 years.
Moral hazard effects are likely amplified by current pension
funding and pension accounting rules that may also encourage plans to
invest in riskier assets to benefit from higher expected long-term
rates of return. In determining funding requirements, a higher expected
rate of return on pension assets means that the plan needs to hold
fewer assets in order to meet its future benefit obligations. And under
current accounting rules, the greater the expected rate of return on
plan assets, the greater the plan sponsor's operating earnings and net
income. However, with higher expected rates of return comes greater
risk of investment volatility, which is not reflected in the pension
insurance program's premium structure. Investments in riskier assets
with higher expected rates of return may allow financially weak plan
sponsors and their plan participants to benefit from the upside of
large positive returns on pension plan assets without being truly
exposed to the risk of losses. The benefits of plan participants are
guaranteed by PBGC, and weak plan sponsors that enter bankruptcy can
often have their plans taken over by PBGC.
current funding rules do not provide sufficient incentives for sponsors
to adequately fund their plans
The pension funding rules, under ERISA and the IRC, have not
provided sufficient incentives for plan sponsors to properly fund their
benefit obligations. The funding rules generally presume that pension
plans and their sponsors are ongoing entities and therefore allow for a
certain extent of plan underfunding that can be made up over time.
However, the measures of plan funding used to determine contribution
requirements can significantly overstate the true financial condition
of a plan. And even these reported funding levels indicated significant
levels of underfunding in our study of the 100 largest DB plans.\24\
Furthermore, when plan sponsors make contributions to their plans, they
can use account credits, rather than cash, even in cases when plans are
underfunded. The funding rules include certain mechanisms--primarily,
the AFC--that are intended to prevent plans from becoming too
underfunded. However, our analysis shows that for several reasons, the
AFC proved ineffective in restoring financial health to poorly funded
plans.
rules may allow plans to overstate their current funding levels
Current funding rules may allow plans to overstate their current
funding levels to plan participants and the public. Because many plans
in our sample chose legally allowable actuarial assumptions and asset
valuation methods that may have altered their reported liabilities and
assets relative to market levels, it is possible that funding over our
sample period was actually worse than reported.
Although as a group, funding levels among the 100 largest plans
were reasonably stable and strong from 1996 to 2000, by 2002, more than
half of the largest plans were underfunded (see fig. 3). On average,
each year 39 of these plans were less than 100 percent funded, 10 had
assets below 90 percent of their current liabilities, and 3 plans were
less than 80 percent funded. In 2002 there were 23 plans less than 90
percent funded.
Figure 3: Almost One-Fourth of the Largest Pension Plans Were Less than
90 Percent Funded on a Current Liability Basis in 2002
Reported funding levels may have been overstated for a number of
reasons. These include the use of above-market interest rates, which
leads to an understatement of the cost of settling benefit obligations
through the purchase of group annuity contracts. Also, actuarial asset
values may have differed by as much as 20 percent from current market
value of plan assets. The funding rules allow for smoothing out year-
to-year fluctuations in asset and liability values so that plan
sponsors are gradually, and not suddenly, affected by significant
changes in interest rates and the values of their assets. When current
interest rates decline, the use of a 4-year weighted average interest
rate lags behind, and thus measurements of the present value of plan
liabilities do not accurately reflect the cost of settling a plan's
benefit obligations.\25\
The terminations of the Bethlehem Steel and LTV Steel pension plans
in 2002 (two of the largest plan terminations, to date) illustrate the
potential discrepancies between reported and actual funding. In 2002,
the Bethlehem Steel Corporation reported that its plan was 85.2 percent
funded on a current liability basis, yet the plan terminated later that
year with assets of less than half of the value of promised benefits.
In 2001, LTV Steel reported that its plan for hourly employees was 80
percent funded, yet when the plan terminated in March 2002, it was only
52 percent funded. From these terminations PBGC's single-employer
program suffered losses of $3.7 billion and $1.6 billion,
respectively.\26\
most sponsors most years made no cash contributions to plans but
satisfied funding requirements through use of accounting credits
The amount of contributions required under IRC minimum funding
rules is generally the amount needed to fund benefits earned during
that year plus that year's portion of other liabilities that are
amortized over a period of years. This minimum contribution requirement
may be met by the plan sponsor putting cash into the plan or by
applying earned funding credits. These funding credits are not measured
at their market value and are credited with interest each year,
according to the plan's long-term expected rate of return on
assets.\27\ When the market value of a plan's assets declines, the
value of funding credits may be significantly overstated.
For the 1995 to 2002 period, the sponsors of the 100 largest plans
each year on average made relatively small cash contributions to their
plans (see fig. 4). Annual cash contributions for the 100 largest plans
averaged approximately $97 million on plans averaging $5.3 billion in
current liabilities (in 2002 dollars). This average contribution level
masks a large difference in contributions between 1995 and 2001, during
which period annual contributions averaged $62 million (in 2002
dollars), and in 2002, when contributions increased significantly to
$395 million per plan. Further, in 6 of the 8 years in our sample, a
majority of the largest plans made no cash contribution to their plan.
On average each year, 62.5 plans received no cash contribution,
including an annual average of 41 percent of plans that were less than
100 percent funded.
Figure 4: Most Large Plans Received No Annual Cash Contribution, 1995-
2002
Note: Average contributions for 2002 are largely driven by one
sponsor's contribution to its plan. Disregarding this $15.2 billion
contribution reduces the average plan contribution for 2002 from $395
million to $246 million.
As stated earlier, Bethlehem Steel and LTV Steel both had plans
terminate in 2002 that were only about 50 percent funded. Yet each plan
was able to forgo a cash contribution each year from 2000 to 2002,
instead using credits to satisfy minimum funding obligations, primarily
from large accumulated credit balances from prior years. Despite being
severely underfunded, each plan reported an existing credit balance at
the time of termination.
afc, primary mechanism for improving funding of underfunded plans,
proved ineffective
The funding rules' primary mechanism for improving the financial
condition of underfunded plans, the additional funding charge proved
ineffective in helping underfunded plans for four main reasons:
1. Very few plans in our sample were actually assessed an AFC
because the rules, despite the statutory threshold of a 90 percent
funding level for some plans to owe an AFC, in practice require a plan
to be much more poorly funded to be subject to this requirement.\28\
From 1995 to 2002, an average of only 2.9 of the 100 largest DB plans
each year were assessed an additional funding charge, even though on
average 10 percent of plans each year reported funding levels below 90
percent. Over the entire 8-year period, only 6 unique plans that were
among the 100 largest plans in any year from 1995 to 2002 owed an AFC.
These 6 plans owed an AFC during the period a total of 23 times in
years in which they were among the 100 largest plans, meaning that
plans that were assessed an AFC were likely to owe it again.
2. AFC rules also specify a current liability calculation method
that may overstate actual plan funding, relative to market-value
measures, thereby reducing the number of plans that might be assessed
an AFC. The specified interest rate for this calculation exceeded
current market rates in 98 percent of the months between 1995 and 2002.
3. The AFC rules generally call for sponsors to pay only a
percentage of their unfunded liability, rather than requiring
restoration of full funding. On average, by the time a plan was
assessed an AFC, it was significantly underfunded and was likely to
remain chronically underfunded in subsequent years. Among the 6 plans
that owed the AFC, funding levels rose slightly from an average of 75
percent when the plan was first assessed an AFC to an average of 76
percent, looking collectively at all subsequent years. All of these
plans were assessed an AFC more than once.
4. Plan sponsors can meet the AFC requirement by applying funding
credits earned in prior years in place of cash contributions. The
account value of these credits, which accumulate interest, may not
reflect the underlying value of the assets in the plan. Many plans
experienced significant market value losses of their assets between
2000 and 2002 while they were able to apply these funding credits.
Among the 100 largest plans, just over 30 percent of the time a plan
was assessed an AFC, the funding rules allowed the sponsor to forgo a
cash contribution altogether that year.
The experience of two large terminated plans illustrates the
ineffectiveness of the AFC. For example, Bethlehem Steel's plan was
assessed an AFC of $181 million in 2002, but the company made no cash
contribution that year, just as it had not in 2000 or 2001, years in
which the plan was not assessed an AFC. When the plan terminated in
late 2002, its assets covered less than half of the $7 billion in
promised benefits. LTV Steel, which terminated its pension plan for
hourly employees in 2002 with assets of $1.6 billion below the value of
benefits, had its plan assessed an AFC each year from 2000 to 2002, but
for only $2 million, $73 million, and $79 million, or no more than 5
percent of the eventual funding shortfall. Despite these AFC
assessments, LTV Steel made no cash contributions to its plan from 2000
to 2002. Both plans were able to apply existing credits instead of cash
to satisfy minimum funding requirements. In addition, both sponsors had
unused funding credits at the time their plans were terminated.
weaknesses in funding rules amplified by lack of transparency hinders
sound policy making
Unclear measures of pension funding and a lack of timely
information have made it difficult for plan participants, investors,
regulators, and policy makers to accurately assess the financial
condition of pension plans. Without timely and reasonably accurate data
about the financial condition of pension plans, the various
stakeholders cannot make timely and informed decisions on retirement
savings, employment, and other key life issues. The primary regulatory
filing for pension plans--the Form 5500--requires multiple measures of
pension assets and liabilities, yet none of these measures tell PBGC
and plan participants what share of the benefit obligations are funded
in the event of plan termination. Furthermore, by the time these
regulatory reports are publicly available, the information is usually
at least 2 years old.\29\ In a time of significant changes in interest
rates and equity prices, it is possible that reported measures of
pension funding will substantially differ from current measures of plan
funding. PBGC does receive more current information about plans that
are underfunded by at least $50 million. This more current information
includes estimates of funding measures if the plan were to be
terminated; however, by law this information is not disclosed to the
public.
Our cash-based budgetary framework for Federal insurance programs
also contributes to a lack of transparency that, at worst, may create
disincentives for policy makers to enact reform measures.\30\ With the
current cash-based reporting, premiums for insurance programs are
recorded in the budget when collected, and outlays are reported when
claims are paid.\31\ This focus on annual cash flows generally does not
adequately reflect the government's cost for Federal insurance programs
because the time between the extension of the insurance, the receipt of
premiums and other collections, the occurrence of an insured event, and
the payment of claims may extend over several budget periods. As a
result, the government's cost may be understated in years that a
program's current premium and other collections exceed current payments
and overstated in years that current claim payments exceed current
collections. This is especially problematic in the case of pension
insurance because of the erratic occurrence of plan terminations as
well as the mismatch between premium collections and benefit payments
that can extend over several decades.
Cash-based budgeting also may not be a very accurate gauge of the
economic impact of Federal insurance programs. Although discerning the
economic impact of Federal insurance programs can be difficult, private
economic behavior generally is affected when the government commits to
providing insurance coverage. In the case of PBGC, the existence of
pension insurance may encourage plan sponsors and employees to agree to
pension benefit increases in lieu of wage increases when the plan
sponsor faces economic difficulties.\32\
Cash-based budgeting for Federal insurance programs may provide
neither the information nor incentives necessary to signal emerging
problems, make adequate cost comparisons, control costs, or ensure the
availability of resources to pay future claims. Because the cash-based
budget delays recognition of emerging problems, it may not provide
policy makers with information or incentives to address potential
funding shortfalls before claim payments come due. Policy makers may
not be alerted to the need to address programmatic design issues
because, in most cases, the budget does not encourage them to consider
the future costs of Federal insurance commitments. Thus, reforms aimed
at reducing costs may be delayed. In most cases, by the time costs are
recorded in the budget, policy makers do not have time to ensure that
adequate resources are accumulated to pay for them or to take actions
to control them. The late budget recognition of these costs can reduce
the number of viable options available to policy makers, ultimately
increasing the cost to the government.
retirement income security requires meaningful and comprehensive reform
In light of the intrinsic problems facing the defined benefit
system, meaningful and comprehensive pension reform is required to
ensure that workers and retirees receive the benefits promised to them
and to secure PBGC's financial future. While PBGC's current financial
condition does not represent a crisis, delaying reform will result in
serious adverse consequences for plan participants, the Federal budget,
and our nation's economy. At this time, the Administration, Members of
Congress, and others have proposed reforms that seek to address many of
the problems facing PBGC and the defined benefit system.\33\ Such
comprehensive effective pension reform would likely include elements
that would improve measures of pension funding and enhance transparency
of plan information, strengthen funding rules (while preserving some
contribution flexibility for plan sponsors, modify certain PBGC
guarantees, develop an enhanced and more risk-based insurance premium
structure, and resolve outstanding controversies concerning hybrid
plans, such as cash balance plans.\34\
gao has suggested elements of pension reform
Pension reform is a challenge because of the necessity of fusing
together so many complex, and sometimes competing, elements into a
comprehensive proposal. Ideally, effective reform would
improve the accuracy of plan funding measures while
minimizing complexity and maintaining contribution flexibility;
revise the current funding rules to create incentives for
plan sponsors to adequately finance promised benefits;
develop a more risk-based PBGC insurance premium structure
and provides incentives for sponsors to fund plans adequately;
address the issue of underfunded plans paying lump sums
and granting benefit increases;
modify PBGC guarantees of certain plan benefits (e.g.,
shutdown benefits);
resolve outstanding controversies concerning hybrid plans
by safeguarding the benefits of workers regardless of age; and
improve plan information transparency for pension plan
stakeholders without overburdening plan sponsors.
Furthermore, if policy makers decide to provide measures of relief
to sponsors of poorly funded pension plans, there should be mechanisms
built into such laws that would prevent any undue exacerbation of
PBGC's financial condition.
Developed in isolation, solutions to some of these concerns could
erode the effectiveness of other reform components or introduce
needless complexity. As deliberations on reform move forward, it will
be important that each of these individual elements be designed so that
all work in concert toward well-defined goals. Even with meaningful,
carefully crafted reform, it is possible that some defined benefit plan
sponsors may choose to freeze or terminate their plans. While these are
serious concerns, the overarching goals of balanced pension reform
should be to protect workers' benefits by providing employers the
flexibility they need in managing their pension plans while also
holding those employers accountable for the promises they make to their
employees.
The debate over defined benefit pension reform should not take
place in isolation of larger related issues. Challenges in the defined
benefit system, together with the recent public debate over the merits
of including individual accounts as part of a more comprehensive Social
Security reform proposal, should lead us to consider fundamental
questions about how who should bear certain risks and responsibilities
for economic security in retirement.
Individual savings require greater responsibility and
offer greater potential rewards and the possibility of bequeathing any
unused retirement savings. However, longevity risk--the risk of
outliving retirement savings--and poor investment choice are
significant concerns, particularly as health care and long-term care
costs and life expectancies continue to rise.
The Federal Government is in the best position to share
risk across the population, and social insurance programs, including
Social Security, Medicare, and Medicaid already reflect this fact.
However, the current structure of existing Federal retirement programs
is unsustainable.
Employer-sponsored pensions can alleviate longevity risk
for plan participants and are generally presumed to be better placed to
manage investment risk. However, poor management of plans can lead to
shortfalls in funding that can damage the competitiveness of the plan
sponsors. Furthermore, many employers are cutting or reducing retiree
health benefits, and even employee health benefits, as growing health
care costs threaten their competitiveness.
experts identified a variety of broad pension reforms
Earlier this year, GAO convened a forum on the future of the
defined benefit system and the PBGC that included a diverse group of
about 40 pension experts, representing various interests, to discuss
various reforms to the defined benefit pension system.\35\ In addition
to debating changes to the funding rules and PBGC premiums,
participants also talked about ways to address pension legacy costs
(the costs of terminated and underfunded pension plans) and features of
pension plans that government policy should encourage.
According to participants in the GAO forum, resolution of pension
legacy costs and clarification of the legal status of cash balance and
other hybrid pension plans could play a significant role in shoring up
the defined benefit system.\36\ Separating legacy costs from the
existing and future liabilities of the remaining defined benefit plans
might encourage plan sponsors to remain in the defined benefit system.
Many plan sponsors are concerned that through increased PBGC premiums,
they may be required to pay for the failures of other companies to
responsibly fund and manage their pension plans. Some participants
added that resolving legacy costs could be a key component of any
pension reform legislation that tightened the funding rules and
assessed premiums according to PBGC's risk. Also, some participants
supported, and other participants opposed, the idea of separately
addressing the pension legacy costs of specific industries, such as
airlines and steel, which have imposed the most significant costs on
PBGC. Separately addressing pension legacy costs does not necessarily
imply a taxpayer bailout, as some participants suggested other ways to
cover their cost, such as through an airline ticket fee to cover the
airlines' share of PBGC's deficit. Others noted that resolving the
uncertain legal status of cash balance and other hybrid pension plans
could encourage greater participation in the defined benefit system.
Expanding the universe of pension plan sponsors could lead to an
increase in PBGC's premium income.
Some forum participants also suggested that the debate over Federal
retirement policy needs to move beyond distinctions between defined
benefit and defined contribution plans. Others added that discussions
of retirement policy need to focus on ways to create incentives and
remove barriers for employers to set up retirement plans, and how to
get American workers to build adequate retirement savings and security.
This may be achieved by thinking about the interaction of private
pensions and Social Security and by looking at hybrid pension plans,
such as cash balance plans and plans that combine the best features of
defined benefit and defined contribution plans. Participants suggested
new pension plan designs be developed that explore the following
features:
allowing automatic participation of the covered population
in order to expand pension coverage generally;
improving the portability of pension benefits to
accommodate workers who frequently change jobs;
providing for professional money management and pooled
investment risk;
minimizing early withdrawals and borrowing--a problem
known as leakage--from retirement savings; and
providing incentives to receive benefits in the form of a
fixed annuity, rather than a lump-sum distribution.
conclusions
Widely reported recent large plan terminations by bankrupt sponsors
and the resulting adverse consequences for plan participants and the
PBGC have pushed pension reform into the spotlight of national concern.
Our analysis here suggests that a variety of factors have contributed
to the current state of affairs: recent declines in interest rates and
financial markets, a soft economy, industry restructuring because of
changes in the national and world economies, weaknesses in the legal
framework governing pensions that has encouraged moral hazard by
sponsors, the underfunding of plans, and a lack of timely, accurate,
useful and transparent information that limits participants, unions,
investors and other stakeholders from being able to make accurate and
timely decisions.
In light of the intrinsic problems facing the defined benefit
system, meaningful and comprehensive pension reform is required to
ensure that workers and retirees receive the benefits promised to them.
At this time, the Administration, Members of Congress, and others have
proposed reforms that seek to address many of the problems facing PBGC
and the defined benefit system. This is a promising development that
can be a critical first step in addressing part of the long-term fiscal
problems facing this country. Such reform will demand wisdom and
patience, given the necessity of fusing together so many complex, and
sometimes competing, elements into a comprehensive proposal. Ideally,
effective reform would
improve the accuracy of plan funding measures while
minimizing complexity and maintaining contribution flexibility;
revise the current funding rules to create incentives for
plan sponsors to adequately finance promised benefits;
develop a more risk-based PBGC insurance premium structure
and provides incentives for sponsors to fund plans adequately;
address the issue of underfunded plans paying lump sums
and granting benefit increases;
modify PBGC guarantees of certain plan benefits (e.g.,
shutdown benefits);
resolve outstanding controversies concerning hybrid plans
by safeguarding the benefits of workers regardless of age; and
improve plan information transparency for pension plan
stakeholders without overburdening plan sponsors.
However, it is also necessary to keep in mind that pension reform
is only part of the broader fiscal, economic, workforce, and retirement
security challenges facing our nation. If you look ahead in the Federal
budget, Social Security, together with the rapidly growing health
programs (Medicare and Medicaid), will dominate the Federal
Government's future fiscal outlook. These are far larger and more
urgent challenges, representing an unsustainable burden on future
generations. Furthermore, pension reform should be considered in the
context of the problems facing our nation's Social Security system. How
we reform DB pensions has crucial implications for directions taken in
reforming Social Security. For example, pension reforms that reduce the
scope of the private pension system or change the dominant form of
private pension design may have consequences for those elements of
Social Security reform packages that reduce benefits or include an
individual accounts feature.
This also means that acting sooner rather than later will make
reform less costly and more feasible. Though smaller in scale than
actuarial deficits in Social Security, Medicare, and Medicaid, PBGC's
deficit threatens to worsen our government's long-term fiscal position.
Finally, as with Social Security, it is also important to evaluate
pension reform proposals as comprehensive packages. The elements of any
reform proposal interact; every package will have pluses and minuses,
and no plan will satisfy everyone on all dimensions. If we focus on the
pros and cons of each element of reform by itself, we may find it
impossible to build the bridges necessary to achieve consensus.
We look forward to working with Congress on these crucial issues.
Mr. Chairman, this concludes my statement. I would be happy to
respond to any questions you or other members of the Committee may
have.
endnotes
1. Many of these elements are explored in greater detail in a
report that GAO is releasing today. GAO, Comptroller General's Forum:
The Future of the Defined Benefit System and the Pension Benefit
Guaranty Corporation, GAO-05-578SP (Washington, D.C.: June 9, 2005).
2. GAO, Long-Term Fiscal Issues: The Need for Social Security
Reform, GAO-05-318T (Washington, D.C.: Feb. 9, 2005).
3. GAO, 21st Century Challenges: Reexamining the Base of the
Federal Government, GAO-05-325SP (Washington, D.C.: Feb. 2005).
4. One impetus for the passage of ERISA was the failure of
Studebaker's defined benefit pension plan in the 1960s, in which
thousands of plan participants lost most or all of their pensions.
5. Some defined benefit plans are not covered by PBGC insurance;
for example, plans sponsored by professional service employers, such as
physicians and lawyers, with 25 or fewer employees.
6. GAO, Private Pensions: Recent Experiences of Large Defined
Benefit Plans Illustrate Weaknesses in Funding Rules, GAO-05-294
(Washington, D.C.: May 31, 2005).
7. GAO, Pension Benefit Guaranty Corporation Single-Employer
Insurance Program: Long-Term Vulnerabilities Warrant ``High Risk''
Designation, GAO-03-1050SP (Washington, DC: July 23, 2003).
8. For additional discussion of these broader fiscal challenges,
see GAO, Our Nation's Fiscal Outlook: The Federal Government's Long-
Term Budget Imbalance, at http://www.gao.gov/special.pubs/longterm/
longterm.html.
9. PBGC is authorized to borrow up to $100 million from the U.S.
Treasury to cover temporary cash shortfalls.
10. PBGC also guarantees a smaller pension benefit for
approximately 10 million participants in multiemployer pension plans.
11. According to PBGC officials, PBGC files a claim for all
unfunded benefits in bankruptcy proceedings. However, PBGC generally
recovers only a small portion of the total unfunded benefit amount in
bankruptcy proceedings, and the recovered amount is split between PBGC
(for unfunded guaranteed benefits) and participants (for unfunded
nonguaranteed benefits).
12. The additional premium equals $9.00 for each $1,000 (or
fraction thereof) of unfunded vested benefits. A plan's sponsor may be
exempt from paying the variable rate premium if the plan met a
specified funding threshold in the previous plan year.
13. Present value calculations reflect the time value of money--
that a dollar in the future is worth less than a dollar today, because
the dollar today can be invested and earn interest. Using a higher
interest rate will lower the present value of a stream of payments
because it implies that a lower level of assets today will be able to
fund those future payments.
14. A plan's current liability may differ from its termination
liability, which measures the value of accrued benefits using
assumptions appropriate for a terminating plan. For further discussion
of current versus termination liability, see appendix IV of GAO,
Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance
Program Faces Significant Long-Term Risks, GAO-04-90, (Washington,
D.C.: Oct. 29, 2003).
15. The AFC was introduced by the Omnibus Budget Reconciliation Act
of 1987. See Pub. L. No. 100-203 (1987).
16. Broad equity indexes in the U.S. have risen since 2002 but
remain significantly below their peak levels of 2000.
17. ERISA Industry Committee, Consensus Proposals for Pension
Funding, PBGC Reform, and Hybrid Pension Plans, (Washington, D.C.: May
2005). Asset totals in 2002 and 2004 include billions of dollars in
contributions by plan sponsors since 1999.
18. Falling interest rates raise the price of group annuities that
a terminating plan must purchase to cover its promised benefits and
increase the likelihood that a terminating plan will not have
sufficient assets to make such a purchase. A potentially offsetting
effect of falling interest rates is the possible increased return on
fixed-income assets that plans hold. When interest rates fall, the
value of existing fixed-income securities with time left to maturity
rises.
19. Three of the last five annual increases in bankruptcies
coincided with recessions, and the record economic expansion of the
1990s is associated with a substantial decline in bankruptcies. Annual
plan terminations resulting in losses to the single-employer program
rose from 83 in 1989 to 175 in 1991, and after declining to 65 in 2000,
the number reached 93 in 2001. The last three recessions on record in
the United States occurred during 1981, 1990-91, and 2001 (See
www.bea.gov/bea/dn/gdpchg.xls).
20. The causes of restructuring are likely industry-specific. For
example, the U.S. airline industry, which has many pension plans in
poor financial condition, has faced profit pressures as a result of
severe price competition, terrorism, the war in Iraq, and the outbreak
of severe acute respiratory syndrome (SARS), creating bankruptcies and
uncertainty about the future financial health of the industry.
21. A major factor contributing to the increase in lump-sum
distributions from defined benefit plans is the growing prevalence of
hybrid plans, such as cash balance plans, which typically offer lump
sums. Hybrid plans are a form of DB plan that determines benefits on
the basis of hypothetical individual accounts.
22. GAO-05-294.
23. Boyce, Steven, and Richard A. Ippolitio, ``The Cost of Pension
Insurance,'' The Journal of Risk and Insurance, (2002) Vol. 69, No. 2,
pp.121-170.
24. For further details of this study, covering 1995-2002, see GAO-
05-294. These 100 plans are not a closed group. The 100 largest plans,
as measured by current liability, changed from year to year for various
reasons, including mergers and divestitures of plan sponsors. A total
of 187 distinct plan identifiers were included in our sample, and 25 of
them were in each year's sample.
25. Conversely, when interest rates rise, the opposite would be
true, and the weighted average would make the cost of settling plan
liabilities higher than the current market rate would indicate.
26. Several factors may explain the wide discrepancy between
reported funding levels and actual funding levels at termination.
Reported funding levels may use an actuarial value of assets, which may
exceed the market value at termination. In addition, termination
liabilities are valued using a different interest rate than that used
for current liabilities. Further, current liabilities and termination
liabilities may be measured at different times. Unfunded shutdown
benefits may also raise termination liabilities. For more discussion of
the differences between termination and current liabilities, see GAO-
04-90, appendix IV.
27. See 26 U.S.C. 412(b).
28. A plan is not subject to an AFC if the value of plan assets (1)
is at least 80 percent of current liability and (2) was at least 90
percent of current liability for at least 2 consecutive of the 3
immediately preceding years.
29. For further information about problems with the content and
timeliness of regulatory reports on pensions, see GAO, Private
Pensions: Government Actions Could Improve the Timeliness and Content
of Form 5500 Pension Information, GAO-05-491 (Washington, D.C.: June 3,
2005), and Private Pensions: Publicly Available Reports Provide Useful
but Limited Information on Plans' Financial Condition, GAO-04-395
(Washington, D.C.: Mar. 31, 2004).
30. GAO, Budget Issues: Budgeting for Federal Insurance Programs,
GAO/T-AIMD-98-147 (Washington, D.C.: Apr. 23, 1998), and Budget Issues:
Budgeting for Federal Insurance Programs, GAO/AIMD-97-16 (Washington,
D.C.: Sept. 30, 1997).
31. PBGC's premium collections and benefit payments are recorded in
the budget on a cash basis, regardless of when the commitments are
made. The premiums paid by participants are held in a revolving fund.
PBGC's budget treatment is complicated by the use of a second account
for some activities which is not included in the Federal budget. This
account records the assets and liabilities that PBGC acquires from
terminated plans. As a result, the budget only reports PBGC's net
annual cash flows between its on-budget account and all other entities,
including the other PBGC account. It does not provide information on
liabilities PBGC incurs when it takes over an underfunded plan or other
changes in PBGC's assets and liabilities.
32. GAO-05-578SP.
33. For example, earlier this year, the Administration released a
proposal that focuses on reforming the funding rules; improving
disclosure to workers, investors, and regulators about pension plan
status; and adjusting premiums to better reflect a plan's risk to PBGC.
See U.S. Department of Labor, Employee Benefits Security
Administration, Strengthen Funding for Single Employer Pension Plans,
February 7, 2005.
34. For greater detail, see GAO-04-90.
35. GAO, Comptroller General's Forum: The Future of the Defined
Benefit System and the Pension Benefit Guaranty Corporation, GAO-05-
578SP (Washington, DC: June 2005). Participants included government
officials, researchers, accounting experts, actuaries, plan sponsor and
employee group representatives, and members of the investment
community.
36. Cash balance plans are a type of defined benefit plan that look
more like a defined contribution plan to participants. As with other
defined benefit plans, the sponsor is responsible for managing the
plan's commingled assets and complying with the minimum funding
requirements. However, information about benefits is communicated to
plan participants through the use of hypothetical account balances,
which makes the plan appear like an individual account-based defined
contribution plan. The hypothetical account balances communicated to
plan participants do not necessarily bear any relationship to actual
assets held by the plan.
Chairman Nussle. I thank the witness.
Next we will hear from the distinguished Director of the
Congressional Budget Office.
Welcome back. Your entire testimony will be made part of
the record, and you may proceed.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL
BUDGET OFFICE
Mr. Holtz-Eakin. Thank you, Mr. Chairman, Mr. Spratt and
members of the committee.
The CBO is indeed pleased to be here and have a chance to
testify once more. The PBGC issue is an important and timely
one, and there is an enormous range of issues which we might
explore, perhaps in the question-and-answer.
I am going to restrict these remarks to the work that is
ongoing at the CBO at the request of the committee, which is
focused on budgeting for loans, guarantees and insurance in the
Federal budget.
I will make three main points. The first will be to provide
a sense of the scale of the economic commitment represented by
insurance for defined benefit pension plans.
The second will be to raise the question of just how much
of this commitment will be picked up by the U.S. taxpayer.
And the third will be to explore effective ways to inform
the Congress and other stakeholders of the budgetary resources
that might be involved in these commitments.
Now I want to echo the comments of Mr. Spratt and emphasize
at the outset that this is a work in progress. As we continue
our work, and refine our approach, the numbers will change.
Nevertheless, we believe that our work is sufficiently
mature that one can get a sense of the magnitudes involved. We
are here today to talk about that.
The numbers that you will see and hear today have in front
of them labels like economic costs. These are different, and
deliberately different, from traditional budget estimates.
Indeed, our goal is to step back and look at cost in a
different and broader context. In fact, we try to estimate the
market value of the financial resources that are being
transferred to or within the pension system.
So with those opening warning labels, let's take a look at
the three questions.
Question No. 1: How big is the insurance problem
represented by the PBGC? And here the technique is to try to
estimate market values. Figuratively, we are trying to answer
the question, how big a check would you need to write to the
financial markets to purchase the insurance policy of the PBGC?
I will skip the financial rocket science buried in the
computations and simply point out that we are going through the
steps a financial analyst would go through in deciding how
large an insurance premium to demand.
Step one is to estimate the probability of a sponsor's
bankruptcy. Our estimates are based on the initial assets and
liabilities of those firms that sponsor defined benefit plans.
Using projected evolutions in the value of those assets and
liabilities, we calculate the probabilities of bankruptcy,
given economic conditions in the future.
Step two is to estimate the distribution of underfunding
which will be present in any plan, given that bankruptcy did
occur.
To do that, we need to take into account both the current
funding rules and any potential changes that the Congress might
wish to consider, so as to be able to project the contributions
that would have been made by these firms before they arrive at
bankruptcy.
Step three is to do the valuation of that particular
underfunding. When a plan goes into bankruptcy and it is handed
over to the PBGC, economic conditions are likely to be bad. And
markets demand greater compensation for agreeing to give up
valuable cash in bad times than they do in good times.
The experience of recent years is illustrative. Bad times
are characterized by broad economic dips which place pressures
on cash flows for firms. Revenues tend to be weak and equity
market performance is typically less than stellar, which in
this case would reduce the value of assets in pension plans.
Poor economic times are also typically characterized by low
interest rates, which raise the valuation of the liabilities of
pension plans.
So in the circumstances where markets are most unwilling to
hand over valuable cash are exactly those same circumstances in
which pension plans would likely end up at the PBGC. Markets
will price that risk and they will charge a premium in order to
come up with money in those circumstances.
Given those three broad pieces of the analysis, we can
gauge the costs facing the PBGC from an economic point of view.
The first slide gives you a notion of two kinds of costs.
The first is what we refer to as sunk costs. These are the
costs of those plans which are in actuality or in effect
already at the PBGC. This is the $23 billion number of the
liabilities of the PBGC in excess of assets that they have
collected already. And those cannot be avoided by prospective
policy changes.
Mr. Spratt. And that is for the duration of the plans that
the government has taken over, then. There is no time limit to
that, except that eventually all the employees who have an
inexorable benefit get their adjusted benefit payment, and that
is it.
Mr. Holtz-Eakin. That is right. And that is that bottom
number.
But the remaining numbers are forward-looking costs over
different horizons: 10, 15, or 20 years. Those are the likely
value of insurance to defined benefit plans over the next
decade or two decades.
So the first number indicates that markets would require a
$48 billion check to cover claims in the next 10 years at the
PBGC. Clearly, as one allows time to go forward, the
probability of more plans arriving at the PBGC----
Mr. Spratt. And this is the present value of expected
terminations over a 10-year period of time. Going out for 10
years.
Mr. Holtz-Eakin. This is the check now----
Mr. Spratt. Present value.
Mr. Holtz-Eakin. The check now, present value, to cover
terminations over the next 10 years, in market terms. Or 15 or
20.
It gives you a sense of the scale of the financial
resources that will be necessary at the PBGC in order to cover
the future obligations of the defined benefit pension system.
Now those estimates assume the continuation of current
funding policies and premiums.
One could imagine changing policy and looking at the
effects on cost.
The next slide shows 10-year effects of some illustrative
policies.
Raising the flat-rate premium, currently $19, to $30 would
lower prospective net costs over the next 10 years in present
value from $48 billion to $45 billion, a saving of $3 billion
at the PBGC.
You could also change the risk of portfolios held by
pension plans.
Currently portfolios are about 70 percent invested in
equities. Limiting them to a maximum of 30 percent equities
would make the assets of the pension plan safer in financial
terms. This change produces larger savings, $7 billion over the
10-year horizon, bringing the prospective costs to $41 billion.
Or going in the other direction, one could make permanent
the temporary discount rate increase that have been in place
for the past 2 years, as a result of using corporate rates to
replace the rate on 30-year Treasury bonds. If that change were
made permanent, it would raise the prospective costs of
insurance by $5 billion, to a total of $53 billion.
Although estimates are not yet available, I would note that
some other policy changes have potentially larger effects than
changing premiums and discount rates. Those changes involve
funding rules or definitions of liabilities.
In the former category are policies like the
administration's proposal to distinguish for funding purposes
between the investment-grade firms and those firms that have
fallen below investment grade. Those kinds of funding changes
could have a dramatic impact.
Changing funding requirements through changes in the
definition of liabilities could also reduce PBGC costs. The
examples of Bethlehem and LTV that Mr. Walker pointed to are
situations in which shut-down benefits, lump-sum cashouts, all
the things that go on close to termination, raised liabilities
dramatically. Bringing those factors more fully into the
funding requirements would in fact be a beneficial step.
Next slide.
The second important question is just what is the
taxpayers' exposure to this potential liability? Under current
law, it is in principle zero. The law requires that the PBGC be
self-financing. The taxpayer has no legal liability to pick up
any residual claims on the PBGC.
Nonetheless, when its assets are exhausted the PBGC will
find itself in uncharted territory.
Mr. Spratt. If I could interrupt, I think what you are
assuming there is that our liability is to the extent of the
trust fund and no further, are you not?
Mr. Holtz-Eakin. That is right. It would be confined to the
assets that the PBGC has taken from failed plans, plus any
premiums that they have built up.
There is no statutory provision that would allow PBGC to
automatically go to the general fund of the Treasury or to the
taxpayers as a whole. That would require congressional action.
Mr. Spratt. If the PBGC in fact guarantees the scheduled
percentage of pension benefit payable, then we have a
substantial cost beyond the liability of the trust fund, the
resources of the trust fund.
Mr. Holtz-Eakin. Absolutely. And the question then is how
would that cost be picked up? Would it be borne by the workers
in the form of dramatically reduced pension benefits? Or, would
pressures rise to the point where the Congress would consider
devoting more resources, going to the taxpayer and funding the
PBGC?
There are clearly pressures of that sort.
In some industries, notably airlines at present, proposals
have been made to stretch out payments to the pension plans. In
fact, this would raise PBGC's cost. And if Congress goes that
route, it would be hard to imagine turning around and not
actually honoring that kind of a commitment to the worker.
Mr. Walker. With your indulgence, Doug, if I can, having
been head of the agency, the PBGC is not backed by the full
faith and credit of the U.S. Government. The PBGC has the
ability to borrow up to $100 million from the U.S. Government.
That is all they have.
But from a practical standpoint, if the PBGC becomes
insolvent--and I think it is only a matter of when, not a
matter of if, unless there is dramatic and fundamental reform,
then there would be tremendous political pressure put on you to
be able to step in.
The numbers that CBO has come up with, which I think are
excellent, show you the potential exposure to the budget and to
the taxpayers if the Government came in to bail out the PBGC.
Legally the Government is not required to do so, but
practically you would so under tremendous pressure to do so.
Mr. Holtz-Eakin. And that would lead you to what would
happen under different policy changes. And there, the range is
enormous. Literally, the sky could be the limit. You could pick
up the entire economic price tag that we have tried to sketch
out. Or, you could stick to current law and have zero.
It is important in thinking through any policy changes to
recognize both the scale of the commitment that we have tried
to lay out, but also that there will be feedback from other
parts of the budget.
In particular, large increases in premiums which reduce
measured profitability will have revenue effects. And the
committee would be served well to think comprehensively about
the impact of those proposals. And we would be happy to help
you with that.
One of the issues that would arise there as well would be
the degree to which it should be an explicit policy to
subsidize insurance to defined benefit pension plans.
Is it a policy goal to provide resources to the defined
benefit system as a whole? Or should it be the case that the
insurance should not cost the taxpayer anything? If the latter,
then should it be priced and regulated in a way that the firms
come up with the full cost?
And then finally, let me close and turn to the question of
what is the best way to present this information to the
Congress and to this committee?
The next slide shows two vehicles for presenting the
information. One is the standard budget documents including the
appendices. And the second would be the financial statements of
the U.S. Government.
Under current law, as has been noted, all that is shown in
the budget are the cash flows of one part of the PBGC, the on-
budget fund, which is an incomplete financial picture of the
agency as a whole.
The financial statements for PBGC include a report of
probable claims and a contingent liability for claims that are
reasonably possible, which is disclosed in a footnote.
So the current reporting is far short of the kinds of
numbers that might be available if one were to adopt the
structure we have outlined.
On the budget, you could stick with the current setup. Or
one could move toward the direction that the chairman proposed
several years ago and actually accrue the costs, including
perhaps the market risks of providing insurance in bad times.
Or you could pick a middle ground, which would be to
reflect in the budget the de facto subsidy on an annual basis
to the premiums that firms are paying for this valuable
insurance against the risks of default on employee
compensation.
So there are a variety of stylized budget options that one
could go to there, and we could work out more.
And finally, in the financial statements, it would be
straightforward to reflect the full market value of this
insurance, the economic costs de facto being borne by the
system as a whole. And that would improve the nature of the
reporting as well.
So I am pleased to have a chance to present this
preliminary look at our work. It is work that we have done
under the leadership of the committee. We are quite pleased
with the status of things and look forward to working further
with you to bring it to fruition.
[The prepared statement of Douglas Holtz-Eakin follows:]
Prepared Statement of Douglas Holtz-Eakin, Director, Congressional
Budget Office
Chairman Nussle, Mr. Spratt, and Members of the Committee, I am
pleased to discuss the ongoing work that the Congressional Budget
Office (CBO) is doing at the request of this Committee on budgeting for
loans, guarantees, and insurance. Today, I will focus on the economic
costs, Federal costs, and budgetary treatment of the Pension Benefit
Guaranty Corporation's (PBGC's) insurance of defined benefit pension
plans.
At the outset of my statement, however, I would emphasize two
important caveats. First, CBO's efforts to estimate the costs of PBGC
and to identify alternative, potentially more effective budgetary
treatments constitute a work in progress. With further refinements,
CBO's estimates and findings are likely to change somewhat. Second, the
estimates that I will be reporting today are market measures of the
value of financial resources being transferred to or within the
defined-benefit pension system under current law. They are not budget
cost estimates, nor do the estimates of the effects of changes in
policy represent the budget scoring for legislation that would effect
those changes.
As economic--rather than budget cost--measures, the estimates
provide an opportunity to think broadly about Federal policy toward
defined-benefit pension plans. Under current policy, the full cost of
those pensions is not being shouldered by the plans' sponsors. Rather,
because the current rules permit plans to be underfunded and because
pension insurance is underpriced for many plans, some of the costs are
being borne by the plans' beneficiaries and, potentially, by taxpayers.
From a budgetary perspective, the key question is, how much should
taxpayers be required to contribute to the defined-benefit pension
system?
Under current law, PBGC is liable for insured benefits only to the
extent that it has resources from insurance premiums, investment
income, the assets of terminated plans, and recoveries from sponsors.
However, because PBGC is a Federal insurance agency, there is a
widespread belief that its obligations have at least an implied Federal
guarantee that commits the government to use general revenues to honor
insured claims.
In pursuing the objective of reducing or eliminating Federal costs,
policymakers have several general types of approaches available. One
group consists largely of regulatory instruments, including raising
premiums and adjusting them for risk, tightening the pension funding
rules, improving the measurement and reporting of pension liabilities,
and attempting to increase the discipline of private sponsors' funding
decisions. Higher premiums--in particular, ones linked to PBGC's risk
exposure--would offset losses on future claims. More accurate
measurement of plans' liabilities would make the existing funding rules
and premium schedule more effective.
If beneficiaries understood that they were at risk from plans'
underfunding, they would have incentives to press for higher funding or
perhaps another form of compensation. Accordingly, increased
requirements for plans to publicly and frequently disclose sufficient
information about their financial condition could be useful in reducing
Federal costs. Alternatively, privatizing PBGC so that losses were
absorbed by its shareholders or by private reinsurers would also bring
the force of market discipline to the task of controlling PBGC's
losses.
Policymakers could also use budget instruments to help move toward
eliminating Federal costs for PBGC. Increasing the transparency of
PBGC's own financial condition and performance could be as useful as
doing so for the pension plans. For instance, the agency's budget
accounts could be reconfigured to recognize the accruing cost to the
government from pension insurance.
The Congress may also decide that, for various reasons, subsidizing
the defined-benefit pension system is desirable. In that case,
policymakers may be willing to accept some level of expected funding
through general revenues. The same policy instruments could be used to
limit taxpayers' exposure as would be used to eliminate it.
The economic costs of PBGC insurance to taxpayers (if the implicit
guarantee is honored) are substantial. In thinking about reducing those
costs, however, it is critical to distinguish between costs already
incurred and prospective costs. PBGC had accumulated losses of $23.3
billion at fiscal year-end 2004 for single-employer plans that had been
terminated or whose termination the agency regarded as probable.
``Sunk'' costs for plans that have been terminated (in actuality or in
effect) cannot be avoided, and policy decisions can determine only who
will bear those costs. However, policy changes can reduce prospective
costs.
CBO estimates that the economic costs to the public of PBGC
insurance for single-employer plans net of premium collections over the
next 10 years is $48 billion. That figure describes the estimated net
present value of the financial resources that the program will be
transferring to sponsors of and participants in defined-benefit
pensions. It is also the price that the government would have to pay to
private insurers bidding in competitive markets to take on the
obligations that PBGC will assume in that period with current premiums
and funding rules. Adding sunk costs and prospective costs together
results in a total of $71 billion for the upcoming decade, $83 billion
for 15 years, and $91 billion for 20 years.
In terms of the particular instruments that could be used, CBO's
calculations suggest the following:
Premium collections would have to rise fivefold in order
to cut net Federal costs to zero through increases in premiums alone.
For well-funded plans, which do not pay a premium for underfunding, the
increase would be relatively modest, but for severely underfunded
plans, which do pay an underfunding premium ($9 per $1,000 of
underfunding per year), the increase could constitute a large increase
in costs.
Some proposals that the Administration has made, if
enacted, could measurably reduce the economic costs of the system. For
example, increasing premiums from $19 to $30 per participant would
reduce 10-year net economic costs by $3 billion, while the proposed
tighter rules for calculating pension liabilities and the proposed
requirements for increased funding by financially distressed sponsors
could reduce prospective economic costs significantly.
Other policy changes such as reducing the maximum share of
a pension plan's assets that could be invested in equities (stocks) to
30 percent from the current unregulated level of about 70 percent would
reduce costs by $7 billion over 10 years.
Some changes currently being considered could increase
prospective costs. For example, making permanent a legislated increase
in the discount rate used to calculate the present value of pension
liabilities would increase PBGC's net costs by $5.3 billion. Increasing
the average time permitted for closing a plan's funding gap by 2 years
would raise net costs by $6 billion.
Changing the budgetary treatment of PBGC or changing its
ownership by paying a private entity to take it over would not directly
affect net costs but could increase the visibility of those costs and
contribute to improved monitoring by the Congress.
Estimating the Costs of PBGC
The recent takeover of several airlines' pension plans by the
Pension Benefit Guaranty Corporation has focused attention on and
raised concerns about this program's costs to the government,
taxpayers, the plans' sponsors, and the plans' participants. However,
the budgetary and financial information currently available about PBGC
is not very informative about the likely costs of the takeovers or the
incidence of those costs.
One reason for the absence of such information is that Federal
pension insurance gives a large number of beneficiaries valuable but
highly uncertain claims to future payments. A natural approach to
determining the costs of such claims is to find market prices for
equivalent uncertain commitments. Although no exact match is currently
available in private markets, finance specialists have developed
techniques for using the prices of securities that are bought and sold
to price contracts that are not traded. In the case of PBGC, the value
of defined-benefit pension insurance is equivalent to a type of put
option. Specifically, the option held by a pension plan's beneficiaries
is to sell, or put, the assets of the plan to PBGC at a price equal to
the value of the insured liabilities, contingent on the financial
distress of the sponsor.
CBO has used those techniques along with publicly available
information to project the three key determinants of PBGC's costs: the
probability of a sponsor's bankruptcy, which is necessary before the
put can be exercised; the probability distribution of the plan's
underfunding (the plan's liabilities minus its assets) at termination,
which is the value of the put option when it is exercised (or when the
plan is transferred to PBGC); and market risk (the correlation of
PBGC's claims with bad economic conditions), which affects the discount
rate used to calculate the present value of the option.
The resulting estimated costs are the market value of the financial
resources transferred to the defined-benefit pension system by PBGC.
The estimates are based on information contained in Securities and
Exchange Commission filings by publicly traded sponsors of defined-
benefit pension plans. (Data on privately held companies and
confidential filings that sponsors of publicly traded companies with
significantly underfunded plans submit to PBGC are not available to
CBO.) In the data available to CBO, plans' total liabilities amount to
about 88 percent of those reported by PBGC. Therefore, CBO has scaled
its estimates of PBGC's costs by a factor of 1.14 to adjust them to the
size of the defined-benefit pension system.
The estimates are subject to considerable uncertainty for many
reasons. CBO's estimates rely on firms' reports that are based on
generally accepted accounting principles of pension assets and
liabilities, whereas PBGC's figures rely on firms' reports for the
Internal Revenue Service and under the Employee Retirement Income
Security Act, which indicate a higher initial level of underfunding.
Also, CBO's estimates are based on assumptions that simplify the
complexities of the defined-benefit pension system. For example, all
plans are assumed to fund pensions with the same mix of assets and to
exhibit the same jump in liabilities at termination.
Using those assumptions, CBO estimates that under current policy,
the market price of PBGC insurance going forward for existing plans for
10 years is $48 billion (net of premiums and assets of terminated plans
and recoveries). That figure conveys the present value of the
commitment to take on PBGC's net obligations for existing single-
employer plans for the next 10 years. With the $23.3 billion in
accumulated losses reported by PBGC at year-end 2004, the combined
total of historical and prospective 10-year costs is about $71 billion.
The $23.3 billion in accumulated losses are sunk costs that cannot
be avoided by policy changes now and that will be difficult to recover
from surviving sponsors. As a consequence, policymakers have greater
latitude in focusing on the second component of costs: claims that are
prospective under current policy and, therefore, may be avoided.
Measures to Reduce the Federal Costs of PBGC
Two general regulatory approaches may be useful in reducing the
future net costs of PBGC insurance. The first is to raise insurance
premiums and adjust them for risk. The second is to reduce the level of
risk in the defined-benefit pension system.
raising premiums
Raising premiums would require sponsors to pay a larger share of
costs. To cut Federal costs to zero through higher premiums alone would
require a fivefold increase in PBGC's receipts from premiums. Those
higher premiums might be manageable for well-funded plans, which
currently pay only a flat charge of $19 per year per participant for
insurance. However, for firms with plans that are significantly
underfunded, their current annual premiums also include a charge of $9
per $1,000 of underfunding. A hypothetical firm with 1,000 participants
and $50 million in underfunding would pay premiums of $469,000 per
year, of which $450,000 is the charge for underfunding. Therefore, for
some firms, the increase in premiums could be significant--perhaps to
the point of causing them to adjust the form and level of compensation
that they offer.
reducing or charging for risk
An alternative to a proportionate increase in premiums for all
sponsors would be to make premiums more sensitive to the risk that
various plans pose for PBGC. Although the extra charge for underfunding
currently provides some adjustment based on risk, increasing the
variation in premiums on the basis of risk could reduce the current
cross-subsidies from low-risk sponsors and plans to high-risk ones.
Some risk-adjusted premiums could also strengthen incentives for
sponsors to reduce risk--which could lower the premium rate required to
achieve any given level of net costs.
With this approach, premiums would be higher for sponsors that were
more likely to encounter financial distress and whose plans would tend
to be more deeply underfunded at termination. For example, premiums
could vary with the volatility of the market value of a firm and its
pension assets, the ratio of the firm's liabilities to its equity
(leverage), and the firm's credit rating. The resulting range of
premiums could be substantially wider than it is under current policy
because risk varies significantly among plans. If, for example,
premiums were set so that PBGC's expected net cost for insuring an
investment-grade company (which is within the top four broad ratings
categories) was the same as that for a lower-rated company, they would
need to be about 20 times higher per dollar of liability for the lower-
rated company.
Another important correlate of plans' risk that could provide a
basis for adjusting premiums is the ratio of a pension plan's assets in
equities to its total assets. Sponsors appear to prefer a high
proportion of equities because they expect higher average returns on
stocks than on bonds. If realized, that risk premium would reduce the
cash contributions a sponsor must make to its plan in order to fund the
promised pension benefits. Of course, such investments entail the risk
that the stock market will do poorly and the plan will become
underfunded.
Plans with a high proportion of common stocks, rather than high-
quality bonds or other fixed-income securities, exhibit more volatility
in the value of their assets than do plans holding more debt
securities. Plans with a high share of stocks are thus at greater risk
of underfunding when the sponsors encounter financial distress. That
increase in risk to PBGC means that fair (full-cost) premiums would be
about 16 percent lower for plans with an equity share of 30 percent
rather than the average of almost 70 percent currently found in
defined-benefit pension plans. Such an adjustment in premiums could
create incentives for firms' investment decisions that could lower
costs and improve the match between the risk posed and the premiums
paid. An alternative to relying on the incentive effects of risk-based
premiums to reduce risk would be to limit, through law or regulation,
the share of assets that plans could invest in stocks.
The current structure of premiums tends to disconnect them from
risk because PBGC's costs vary more closely with plans' liabilities
rather than their number of participants. The per-participant charge
also tends to lower the premium per dollar of insured liabilities for
firms with a high proportion of older or high-wage employees compared
with firms whose workforce is predominantly younger or lower paid and
therefore has few accumulated pension benefits. At the current rate of
$19 per participant, those effects may be small, but if rates were
raised to be fair on average, the effects on firms' behavior could be
significant.
A major source of risk to PBGC is the potentially large gap between
the level of pension liabilities reported under the current definitions
and funding rules and the economic value of those liabilities at plans'
termination. PBGC often reports that plans that appeared to be well-
funded prior to termination turn out to be deeply underfunded when they
are transferred to the agency. For example, Bethlehem Steel's plan was
84 percent funded on the basis of current reporting requirements but
was only 45 percent funded at termination.\1\ Underfunding can increase
as a sponsor approaches bankruptcy for several reasons, including the
discretion that the law allows in calculating the present value of a
plan's liabilities and in valuing assets at their purchase price rather
than current market value. (Those same funding rules also permit many
plans that are effectively underfunded to avoid paying the variable-
rate premium of $9 per $1,000 of underfunding.) Changing the definition
and measurement of liabilities and tightening the funding rules,
especially for sponsors with a greater chance of financial distress,
could lessen the risk to PBGC and to the defined-benefit pension
system.
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\1\ Statement of Bradley D. Belt, Executive Director, Pension
Benefit Guaranty Corporation, before the Senate Committee on Finance,
March 1, 2005.
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Increasing the Visibility of PBGC's Costs
The policy changes needed to reduce the costs of pension insurance
might be facilitated by increasing the visibility of PBGC's costs
through changes in the budgetary treatment of pension insurance or
other means. The present budgetary treatment focuses on the cash
inflows to PBGC's on-budget account, primarily from premiums, interest
income, and transfers from an off-budget trust fund, which holds the
assets of plans taken over by PBGC. The inflows are netted against
Federal outlays for pension benefits in plans run by PBGC's trustees
and for administrative expenses. That treatment delays the recognition
of insurance claims, often for decades, from when they are realized at
a plan's termination to when benefits are paid. As a consequence, and
despite large losses, PBGC's budgetary position has contributed to
reducing the Federal deficit in every year except for fiscal year 2003,
when the on-budget account recorded net outlays of $229 million. For
fiscal year 2004, net budget outlays for PBGC were once again negative,
representing a net cash inflow of $247 million. Such budgetary
treatment is not designed to indicate or suited to describing the
expected risk and magnitude of losses in the pension insurance system.
The financial statements issued by PBGC include losses on plans
that have been terminated and those whose takeover the agency can
foresee. In addition, PBGC publishes financial projections based on its
Pension Insurance Modeling System, which indicate that the midpoint of
the agency's distribution of accumulated deficits in 10 years is about
$30 billion. Although both of those indicators of PBGC's financial
status provide useful information to policymakers and are good starting
points for further analysis, the first focuses primarily on losses that
have occurred, including losses on probable terminations (the $23.3
billion cited earlier); and the latter excludes the cost of market
risk.
Information on the present market value of future transfers to the
defined-benefit pension system net of future premiums might be provided
to the Congress through a supplementary reporting system or through
changes in budget presentation. The first approach would offer the
advantage of avoiding the need for changes to the budget, which are
difficult to make piecemeal; the second, the advantage of citing budget
numbers, which are more frequently used for policy decisions than
supplementary information is.
Budgetary treatments of pension insurance that would better
indicate full costs should be the following:
Timely. According to a recommendation of the President's
Commission on Budget Concepts, the budget should reflect outlays when
the government incurs the obligation to pay.\2\ In the case of PBGC,
that point suggests that costs should include losses on pension plans
when they are terminated.
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\2\ President's Commission on Budget Concepts, Report of the
President's Commission on Budget Concepts (October 1967), p. 36.
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Based on Market Value. In general, the budget uses market
prices to measure the value of inputs consumed by various Federal
programs. For consistency, market prices should be used in estimating
insurance costs. For PBGC, the market price of risk is significant
because the events that precipitate a transfer of pension liabilities
to PBGC, including low investment returns, high rates of financial
distress, and low interest rates, occur when the market value of all
assets is down.
Prospective. The costs relevant to budgeting are those to
which the government is committing in the budget period. Although sunk
costs need to be recorded and paid, it is those costs that are being
incurred in the budget period that are the focus of decisions. Of
course, the extent to which the government is committing to pay under
current law is restricted to the resources available to PBGC from
premiums, assets of terminated plans, and recoveries from sponsors.
The current budgetary treatment of PBGC recognizes the inflow of
premium collections during the budget period but not the value of
claims arising under the insurance. It thus falls short of having the
attributes outlined above. CBO is currently exploring budgetary
alternatives that might attain those qualities. One possibility would
be to estimate the net prospective economic costs of PBGC over a
specified period and to treat those values as the budget baseline costs
of the program. Future year budgets could recognize the changes in the
value of the insurance due to changes in law, regulation, or variables
such as insured liabilities or interest rates. In the language of
credit reform, those changes in costs might be treated either as
reestimates (the result of unexpected economic changes) or
modifications (the result of policy changes).
Another possibility would be to structure the accounts to recognize
as budget costs the unpaid fair-value premiums for PBGC insurance. That
is, estimates of the annual premiums required to cut the net budget
costs of insurance to zero could be compared with the premiums expected
to be paid by sponsors, and the difference could be shown as the budget
costs of PBGC.
A more extreme approach would be to transfer PBGC to private
owners. That step would probably accelerate the recognition of past
losses in the budget because the current deficit would have to be
covered, presumably by Congressional appropriations, before a private
entity would be willing to assume the program's obligations. In
addition, a private owner might require either an annual or lump-sum
payment from the government to continue to operate the insurance
program under current funding rules and premiums. Because PBGC
insurance is mandatory for defined-benefit pension plans, the
government would probably remain involved in regulating the terms of
the insurance--which raises the question of the amount of risk and
responsibility the government effectively could transfer to private
owners. Nevertheless, the risk to the government would most likely be
less than it is under current policy.
The Administration's Proposals
The Bush Administration has proposed several changes in the
defined-benefit pension system intended to reduce its financial
shortfall and increase transparency.\3\ Generally, the Administration
would raise premiums and permit further risk-adjustment of them; change
the measure of plans' liabilities and funding requirements; and
increase public disclosures of plans' funding status. Plans' sponsors
would also be permitted to fund the liabilities at higher levels during
good economic conditions (without loss of tax benefits) as a buffer
against underfunding during bad economic conditions and to use a higher
discount rate to calculate plans' liabilities. Most of those changes
are consistent with the objective of reducing the Federal costs of
pension insurance. More specifically, the major provisions being
proposed would do the following:
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\3\ Details are available at www.dol.gov/ebsa/pdf/sepproposal2.pdf.
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Raise the fixed premium per participant from $19 to $30
per year and index the premium to future wage growth. CBO estimates
that this change would reduce the prospective 10-year economic costs of
PBGC insurance by $3 billion.\4\
---------------------------------------------------------------------------
\4\ This estimate does not reflect the budget saving that would be
credited to this provision.
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Authorize PBGC's directors (the Secretaries of Labor,
Treasury, and Commerce) to adjust the variable-rate portion of the
premium so that PBGC's income would cover expected losses. The change
would require more than a sixfold increase in the premiums paid by
plans' sponsors.
Require that plans' liabilities reflect the effects of
early retirements, lump-sum distributions, and increased longevity. The
proposal would also require sponsors with credit ratings below
investment-grade to calculate pension liabilities by assuming that
employees retire at the earliest opportunity, thereby increasing
estimated liabilities. Such sponsors would also be required to fund
completely any increases in the plans' benefits. Although it is
difficult to estimate the effect of the tighter rules for calculating
liabilities, they are potentially the largest source of savings among
the Administration's proposals.
For the purpose of discounting in calculating pension
liabilities, funding requirements, and premiums, mandate the use of a
3-month average of interest rates on corporate bonds whose duration
matches the scheduled payments to beneficiaries. The proposal would
make permanent the change from a Treasury rate to a corporate rate for
discounting pension liabilities. It would permit plans' sponsors to
avoid making up the additional underfunding that resulted from the
legislated increase in discount rates for 2004 and 2005. According to
CBO's estimates, this proposal would increase PBGC's costs by $5
billion over 10 years.
The Administration's proposals incorporate many of the policy
options discussed here to reduce PBGC's risk exposure and to improve
the transparency of the system. However, they also omit several options
that are relatively important for reducing risk exposure and cross-
subsidies between sponsors. First, premiums would continue to be
unrelated to the risk of how pension assets are invested. Second, no
new limitations would be placed on sponsors' investment policies.
Third, the proposals retain a fixed charge per worker, rather than
establishing charges per dollar of coverage, which would perpetuate a
transfer from plans with younger, lower-paid workers to those with a
higher proportion of older workers, higher-paid workers, and retirees.
Chairman Nussle. Thank you to both of our witnesses for
their testimony.
Let me begin by welcoming a new member to the committee,
Chris Chocola, who is here from Indiana. He is filling the slot
that was vacated as a result of Mr. Portman's appointment as
U.S. Trade Representative. We welcome you to the committee,
look forward to your tenure.
Welcome to the committee. You have a $100 billion liability
to deal with. That is just today. [Laughter.]
I look forward to your answer to that. We always give those
problems to the new members.
Let me begin by asking, we have a draft report that I
requested on PBGC, on the liability. And as I have seen--and it
is not, as I understand it, ready for public announcement,
because you are going through the final analysis of the report
before it is realized.
But could you give the committee an understanding of the
$23 billion versus $100 billion numbers that are going to be
compared, that you have talked about a little bit today, but
just to punctuate that one final time. Is it $23 billion that
we are looking at as a long-term liability or are we really
talking about $100 billion, or near $100 billion, as a long-
term liability?
Mr. Holtz-Eakin. Well, $100 billion is a much more sensible
estimate than $23 billion. The $23 billion is done, it has
already happened. Nothing can change that. There will be more
in the future. And the $100 billion number is a forward-looking
estimate of what we know about already and the additional
claims likely to arrive in the future.
Chairman Nussle. And my understanding is for those who were
not here during the S&L crisis--and I was not here during it,
but just coming in at the end of it, my recollection is that it
was approaching a $100-billion concern or crisis as well.
So we are talking about a gigantic challenge that as you
were speculating, while there may not be a legal statutory
obligation, chances are there will be a political answer and a
practical answer that needs to be provided.
We have put in reconciliation for--as far as I am
concerned, and this is the reason I was so adamant about making
sure that we had this instruction available to the Education
and Workforce Committee--available to their jurisdiction, as I
remember, about $12.6 billion of jurisdiction, so that they can
begin to address the problem. Our thumbnail budget estimate was
in the $5 billion range, although that is not a number that is
obligatory to the committee to follow.
Given the opportunity to begin to address this today in a
vehicle such as reconciliation, what would be your
recommendations of a--and I understand there is no such thing
as a quick fix, but would be your first things first if we
could approach this, what would be your recommendations to us
as a committee and to the Congress of the first things first?
Given an opportunity of some jurisdiction now and a vehicle
to accomplish it in reconciliation, what should we consider
approaching first this year, in the next 3 or 4 months, in
order to begin to address the problem?
Mr. Holtz-Eakin. You go first, I will go second.
Mr. Walker. Mr. Chairman, just a point of clarification.
Are you talking about this committee and what is within your
jurisdiction, or are you talking about the Congress as whole?
Chairman Nussle. Both, but we gave the Education and
Workforce, we also obviously have jurisdiction in Ways and
Means that can be used, but let's keep it to the Congress as a
whole.
Mr. Walker. First, I think it is absolutely critical not
just for this area but for other areas within the Federal
budget that we need to have more transparency over the true
discounted present-value cost and exposure associated with this
and other types of Federal programs.
Secondly, I think it is very important that when Congress
is thinking about making changes in the law that it consider
the discounted present-value dollar cost, not just the 10-year
cash flow numbers, for what the potential implications are,
positive or negative, with regard to the Federal budget.
Thirdly, with regard to dealing with the structural
imbalance, as you saw from the excellent CBO analysis, some of
the proposals that people are discussing, like increasing base
premiums, making a few adjustments with regard to the
guarantees, won't come close to solving the problem.
You need to have a package of reforms, just like Social
Security, you need comprehensive pension reform--things like
enhanced transparency with regard to underfunded plans for both
plan participants as well as other key stakeholders, including
the Government; much tougher funding rules for plans that
really represent exposure yet additional flexibility to make
tax deductible contributions in good times, especially for
plans that may not be in trouble today but could be tomorrow;
additional restrictions on the ability to pay lump sum benefits
when a plan is underfunded, therefore having a rush on the bank
potentially; additional PBGC reforms, not just premium reforms,
both flat and variable rate, which should be more risk-related
than it is today, but also issues associated with what types of
benefits are guaranteed, and under what circumstances are they
guaranteed.
You may also need to look at the interaction of the
bankruptcy law and the pension rules, as well as certain other
provisions.
One of the things that the Congress is going to need to
consider is the fact that an overwhelming majority of PBGC's
losses are concentrated in a relatively few firms in less than
a handful of industries.
That is also likely to be the case going forward.
Historically, it has been steel and airlines.
Going forward, it is likely to be more steel, airlines,
autos, and auto-related. Therefore, to a certain extent one of
the things the Congress is going to have to debate is is the
PBGC serving as a backdoor industrial policy mechanism? Should
the PBGC and the premium payers of the PBGC be funding the cost
of global competition and domestic deregulation in some of
these industries, and frankly poor management in others?
There are some very important issues to think about.
Clearly comprehensive pension reform is absolutely essential,
just as Social Security reform is essential.
Last comment, Mr. Chairman. The challenges here are
strikingly similar to Social Security. The only difference is
the numbers. Every day that we wait, the bigger the numbers are
going to get.
Thank you.
Mr. Holtz-Eakin. I think that it is important to recognize
that the kinds of economic costs that are present under current
law are reflective of the reporting environment, the ability to
actually understand the net asset position of these plans, the
regulatory environment, and then also the pricing of that
insurance, that comes last.
The reality is that if one moves to a reconciliation target
in the current budgetary framework, with the cash flow of the
on-budget fund as the centerpiece, the focus will have to be
premiums, specifically on raising premiums.
Our estimate is that it would take an enormous increase in
premiums as a whole, a five-fold increase, in order to bring
the net economic costs down to zero. But this is underpriced
insurance. Raising the premiums would show up in
reconciliation. It would be a desirable policy from this
perspective.
It is also possible to affect the pace at which underfunded
plans make up the shortfall, do their catch-up contributions,
or their DRCs. And that would have some cost-saving
implications as well?
The rest, over a 5-year horizon, is largely baked in the
cake. It is servicing the benefit payments that are going out.
And that is very difficult to affect with policy in the near
term. It is more desirable to think longer term from that
perspective.
The last thing to remember in doing both those is to
remember there will be feedback to the revenue side of the
budget. And you won't get everything that you might think if
you just focus on the outlay side.
Chairman Nussle. Well, it gives us an opportunity this
year, as a result of reconciliation. It is a floor, it is not a
ceiling, meaning that the reconciliation process gives us an
opportunity to open the door a crack, but we could, in fact, go
to a much more comprehensive approach, as you are requesting or
suggesting in your advice to Congress.
I would hope that the committees of jurisdiction hear your
concerns today. And I will make sure that I relate them to the
chairman as well, that we have a challenge here that can be
addressed in the near term with some policies that similar to
Social Security are easier now than they will be 5 years from
now or 10 years from now, if we even get that far before the
crisis manifest itself.
So thank you for your testimony.
Mr. Spratt.
Mr. Spratt. Thank you both for your testimony. If we could
go back, first to General Walker, with the last chart you
showed, which related to the Bethlehem and I believe the LTV
collapse and the consequent assumption of liability by PBGC. If
we could have that chart on the screen, please.
You indicated that, No. 1, I think you averted to this,
when the PBGC finally took hold of the plan assets of Bethlehem
and LTV, they found out that there was a lot less there than
they had previously thought.
Why is that? Does it have something to do with the fact
that 4010, Section 4010 of ERISA (Employee Retirement Income
Security Act), provides confidentiality to these numbers and
they don't get the attention they would get in full public
scrutiny? How is it we can delude ourselves about the balances
in a plan that we are insuring?
Mr. Walker. That is part of the problem, Mr. Spratt. Right
now, if you look in the pension area, you will find that there
are a number of different numbers that are calculated, some of
which are disclosed, some of which are not disclosed.
You will calculate numbers with regard to the funding
status of the plan for determining what your required
contributions are under the minimum funding standards. You will
calculate numbers for purposes of PBGC variable rate premiums.
You will calculate numbers for purposes of public reporting,
especially if you are a public company and file a 10-K.
You will generally find that certain things tend to happen
in connection with troubled companies. No. 1, they use very
optimistic discount rates to determine what their liabilities
are, so they serve to understate their liabilities.
Secondly, and when they had good times with regard to their
asset increases, during times of good markets, they carried
forward those credits, and they are allowed to do that under
current law, even though those gains could have totally
evaporated and turned into losses since then. However, under
current law they are still allowed to consider them for
purposes of meeting their funding requirements.
In the case of LTV Steel, there were shutdown benefits,
those are benefits that arise when a plant shuts down.
Therefore the degree of underfunding can increase dramatically
overnight. As you can see in this graphic, it did.
The bottom line with regard to your premise is, one of the
first things we have to start with is transparency. All too
frequently, the information that is provided to plan
participants and beneficiaries, to the Government and to other
key stakeholders is outdated and misleading.
We need to provide more timely, accurate and useful
information. Transparency is a powerful force in trying to
encourage people to do things that they otherwise should do.
And right now, 4010 is a problem.
Mr. Spratt. As I understand it, there is a provision in
FASB 87, Financial Accounting Standard Board Rule 87, which
deals with the actuarial present value of benefits. And if the
plan assets are beneath the actuarial present value, then the
difference has to be recorded as a liability on your balance
sheet. I guess it gets booked to revenues for that time period,
too.
But in any event, why is that not enough? And if it is not
enough, are you saying then that we need to rescind, we need to
radically change the disclosure rules with respect to the
shelter, the veil that is allowed by Section 4010 of ERISA?
Mr. Walker. There is clearly a need for a change in the law
here, Mr. Spratt. The fact of the matter is, you are correct
that there is a different accounting treatment under generally
accepted accounting principles for pension costs, versus what
has to be provided to plan participants and beneficiaries. It
is also very different than what the funding rules are.
The amounts that are provided in the 10-K, the annual
report filing with the SEC (Securities and Exchange Commission)
for public companies, is usually a lot more reflective of
reality. It is important that more realistic information be
provided in a more timely manner to plan participants and
beneficiaries and other interested parties than is the case
under current law.
Mr. Spratt. Do you agree with that basically, Dr. Holtz-
Eakin?
Mr. Holtz-Eakin. Yes. I think this is a two-step process.
The first is to make sure there is transparency to workers, to
the PBGC, and to shareholders, so they can monitor better the
status of these plans. Similarly, you would like to have better
transparency of the PBGC to the Congress itself, so you can
monitor the status of that commitment.
And second, once you have transparency, what is it that you
would like to reveal? Given that this is an insurance product
and insurance products are about volatility, I think it is
desirable to recognize these things as close to market value as
possible so that you can know when a bad thing is happening and
insurance is going to kick in.
The current reporting structure which emphasizes smoothing
is at odds with providing good information about an insurance
product.
Mr. Spratt. What is the policy behind it? Is there a
concern there would be a run on the stock if there were a
substantial liability or unfunded actuarial value?
Mr. Walker. I think it is important to note that PBGC does
receive certain information under this section----
Mr. Spratt. Confidentially.
Mr. Walker (continuing). Yes, it is confidential. That is
correct.
I think it is important to note that a lot of key
stakeholders aren't like plan participants. Presumably, if they
were very sophisticated investors and they were very familiar
with FASB 87 and FASB 88, if they read the financial statements
of the company closely, and if they looked at the footnotes of
the financial statements, a sophisticated player might be able
to understand what is going on.
However, a vast majority of workers and retirees aren't in
that category. Therefore, we need to provide it in a more
timely and user-friendly fashion, because ultimately this is
not just about PBGC. Ultimately, it is about the retirement
income security of American workers and retirees, because PBGC
does not guarantee all benefits.
There are limits as to what PBGC guarantees. As a result,
significant losses can be imposed on workers and retirees.
Mr. Spratt. Dr. Holtz-Eakin, you have made reference to
premium increases, but you didn't talk about the two types of
premiums--the fixed-rate and the variable-rate premium--and you
also didn't indicate what sort of magnitude of increase would
be necessary to truly mitigate this problem.
Could you address that?
Mr. Holtz-Eakin. Well, our rough estimate is that overall,
if you take both of them, it is about a fivefold increase. The
fixed-rate increase looks far less burdensome on average than
does a variable-rate increase.
The variable rate is hitting those firms which have
underfunded plans. They are typically in less than stellar
financial health themselves. And so imposing that kind of a
premium increase is a far more problematic initial step. I
mean, that is just too abrupt.
Both are appropriate policy instruments. It is important to
use the variable rate to reflect the risk to the PBGC.
Whether you tie that to the kinds of assets in the plans,
or whether you tie it to underfunding, there are a variety of
ways you can go. I think both premiums can be used more fully
to price better. The fixed rate is easier to adjust in the near
term. The variable rate should be structured to provide good
long-term incentives.
Mr. Spratt. Well, just for basic clarification, the fixed
rate applies to every defined benefit plan that is insured by
PBGC. It is $19 per plan participant.
Mr. Holtz-Eakin. Yes.
Mr. Spratt. And one of the proposals, then, would be to
increase that amount.
Obviously, to the extent that it becomes an onerous
increase, you risk the possibility that healthy, financially
solid and stable firms might decide to withdraw as opposed to
paying and convert to defined contribution rather than defined
benefit plans. Is that a concern?
Mr. Holtz-Eakin. For the fixed premium, ballpark numbers--
suppose you use the $19 to $30 as the canonical proposal, that
looks like a couple of pennies per hour in terms of labor
compensation.
Since this is about ensuring that labor compensation
promised at one point in time is actually delivered at another,
that doesn't strike many people as a really big increase from
the point of view of making sure that, that commitment is
honored.
The variable rate is very different; $9 per $1,000 of
underfunding, a sixfold increase in that, or something that
would be necessary to make our kinds of numbers dramatically
smaller, would be a big financial burden if instituted----
Mr. Spratt. And the downside risk is that plans would
terminate and withdraw and then you lose all their
contributions.
Mr. Holtz-Eakin. Yes.
Mr. Spratt. Fixed and variable.
Mr. Walker. If I can, Mr. Spratt?
Mr. Spratt. General Walker?
Mr. Walker. The $19 has not changed since the early 1990s,
so if you index it for inflation it goes to $30. Obviously,
people would prefer for them not to go up, just like people do
not like tax increases--but the relative burden is not likely
to be that significant.
One has to be careful, however, because you have to decide
how much money you need and then how to raise that money.
The current variable-rate premium right now does not
reflect risk. The current variable-rate premium right now is
based solely on the degree of underfunding.
It does not consider the assets in the plan. It does not
consider the nature of the plan and potentially pop-up
liabilities that can come due. It does not consider a number of
important factors that really correlate with risk.
For example, 80 percent of PBGC's losses that have occurred
to date for big plans have been attributable to companies that
had a junk-bond status 10 years from the date that they
terminated--80 percent.
Therefore, actual losses bear a very high correlation to
the financial condition of the sponsor.
Yes, additional premium revenues are necessary, but there
ought to be more of a risk-based variable-rate premium.
You have to be careful not to raise the base rate too much,
to where you encourage the exodus that you talked about. If we
are going to have a variable or so-called risk-related premium,
it really ought to relate to risk--it doesn't right now.
Mr. Spratt. Well, we have got a chart up here now which
indicates how low the premium used to be.
I used to fill out a 5500 C, as I recall it, for a small
firm, a bank, a small bank that we ran. And I think my time
engaged in filling out the form was more expensive than the
premium we had to remit with the form, particularly when you
tried to understand what OMB (Office of Management and Budget)
was putting in the fine print on it.
But thank you both for your testimony. I may have further
questions, but I want to allow others the opportunity.
Thank you very much for your presentations.
Chairman Nussle. Before I turn to the next member, let me
welcome a special guest that is here with Director Holtz-Eakin.
I understand your son is here, welcome Colin. Your dad does a
great service to our country and for our Congress, and we
welcome you to the Budget Committee.
Mr. Chocola for 5 minutes.
Mr. Chocola. Thank you, Mr. Chairman.
First time showing up early in Congress has been rewarded.
Thank you. I appreciate the opportunity to serve on the
committee with you.
And thank you both for being here today. I just quickly
want to follow up on some of your comments, especially Mr.
Walker.
You talked about transparency a lot. You talked about this
is a subset of greater challenges.
I used to work with a publicly traded company, and we were
required to follow things like accrual accounting practices.
And it allowed us to plan for things. And I think in order to
meet a challenge, you have to be able to define a challenge.
If we budgeted on an accrual basis, would we be able to
achieve some of that transparency and be able to plan for these
challenges in a better fashion?
Mr. Walker. No question.
It would make your reconciliation process tougher, because
the numbers would be a lot bigger than you are seeing right
now.
But as you know, there are certain things right now that
are on an accrual basis, certain kinds of credit activities.
But this is not on an accrual basis.
I agree with Doug Holtz-Eakin that we not only need changes
in the budget process, we need changes in the financial
reporting process, and I am trying to make that a reality.
Mr. Chocola. Do you agree, Mr. Holtz-Eakin?
Mr. Holtz-Eakin. I am more cautious than some about moving
the Federal Government full-scale to an accrual framework, for
a whole variety of reasons, and I will spare you the sermon--we
can talk about it later.
I think it is important that the information be entered in
the policy process, that this committee and the Congress in
general know the accrual status of Federal programs.
Budgeting is, in the end, a year-by-year event. The
delivery of budget authority is a management tool by which you
allow people to exercise policy options, and that is a cash
flow operation.
And so I think there is a place for both in thinking about
how the Congress does its business.
Mr. Chocola. Mr. Walker, would you talk about it in the
terms of the bigger challenges that you referred to earlier?
There is a sense of Social Security--I mean, this is a subset
of bigger challenges. The need for transparency is a much
bigger issue than just this, isn't it?
Mr. Walker. Absolutely. Let me give you some numbers.
PBGC has a $23.3 billion accumulated deficit based upon the
numbers we have seen from CBO, which are very similar to the
numbers that PBGC has disclosed itself.
You can easily add another $90 billion to $100 billion on
top of that, so that gets you about $120 billion or so.
Social Security has a discounted present-value unfunded
commitment right now of about $4 trillion. There are 12 zeros
behind that. It is going up every year. That number is just for
75 years, not for perpetuity.
The U.S. Government has liabilities and unfunded
commitments of $45 trillion, which went up over $13 trillion in
the last year alone.
So this is a subset of a range of issues, and we need to
start dealing with them.
Mr. Chocola. And if the Federal Government were a publicly
traded company and it reported its liabilities like the Federal
Government reports its liabilities, it would be understating
its liabilities, wouldn't it?
Mr. Walker. Well, let's talk about what current rules are
and what I am trying to get changed.
By the way, both GAO and CBO sit on the Federal Accounting
Standards Advisory Board (FASAB), which is the body that
recommends accounting and reporting changes.
Right now, there is a separate statement which contains
many of the numbers that I gave you. You can go to and see the
$4 trillion, for example, for Social Security; you can see the
almost $30 trillion for Medicare. They are not currently deemed
to be liabilities for a lot of reasons.
One of the things that we need to do is we need to provide
better transparency over trust fund versus nontrust fund
activity, because as we all know they are not really trust
funds; they are subaccounts of the general ledger.
We need to provide more transparency with regard to the
total liabilities and unfunded obligations, the related burden
on a per-capita basis, and how it fits intergenerationally.
We are dedicated to further improving Federal financial
reporting. In addition to that, because not enough people read
the financial statements, I am not going to ask you to raise
your hand. But I can tell you in the last month, I have given
speeches to hundreds or thousands of people, and less than five
people have read the financial statements of the U.S.
Government.
One of the things we need is a user friendly and concise
summary annual report, in plain English, and with charts and
graphs. I am working with Treasury and OMB to make that happen.
You need to change the budget process too. You don't have
to go to full accrual budgeting--there are pluses and minuses
there.
My understanding is you were just talking about this area
rather than overall.
I do, however, think that there needs to be more
transparency with regard to these commitments and
contingencies, and they need to be accrual numbers. And that
would be a positive first step to help ensure that these issues
are actually considered, discussed and debated.
Mr. Chocola. Mr. Chairman, if I could, I have been baited
into this, I cannot resist.
The PBGC, like many, in principle, private entities, is
different. It was intended to be a funded system. Firms were
either supposed to self insure, by putting aside sufficient
funds to meet the promise of this deferred compensation, or
purchase insurance against adverse economic events that allowed
them to meet that commitment as well. That is standard
operating procedure. And it was intended to be funded either
through internal resources or purchased resources in that
fashion.
Government programs are very different and in some cases,
were never intended to be funded--Social Security and, in
particular, Medicare.
And my reservation with full accrual accounting is best
exemplified by Medicare and Medicaid, where if one takes at
face value the history of the growth of health care costs and
simply extrapolates that into the future, you cannot compute
the present value.
And so the unfunded liability--the funded or unfunded
liability is infinite.
The only way to actually make the computation work is to
assume that at some point in the future health care costs grow
more slowly, and that would be a technical assumption made by
someone--either GAO, CBO, OMB--in consultation with committees.
It strikes me as extraordinarily arbitrary to place the
budgeting framework of U.S. Government on something that
capricious as an assumption that 30 years from now health care
costs will grow more slowly.
That is a reservation I have about implementing that kind
of thinking in the government context.
Mr. Walker. The trustees have to do that every year, and
they have been doing it for many years. Under generally
accepted accounting principles for public-sector companies, as
you know--you used to be involved--you have to do the same
thing.
Nothing is perfect, but I think we need to see some
numbers. They need to be on the radar screen. Right now, they
are not.
You can't solve a problem until you agree that you have a
problem. You also need to see whether or not you are making
progress or making it worse.
Chairman Nussle. Mr. Neal.
Mr. Neal. Thank you, Mr. Chairman.
Mr. Chairman, let me congratulate you for holding this
hearing this morning. It is timely, and I think it speaks to
one of the fundamental problems with this Congress. I
frequently refer to this Congress, as you know, as the Stepford
Congress. Whatever the administration says, the majority in
this Congress goes along with.
As the war in Iraq goes badly, we insist it is going fine.
Cut taxes five times with two wars, and we would say, well, the
budget is fine, we don't have to worry about the deficits. And
then the argument becomes, well, it would have been worse if we
didn't cut taxes in terms of the temporary recession we
experienced.
It seems as though that transparency reference that you
made at least 25 times in your opening statement, Mr. Walker,
really is something that Congress has been very slow to come
to.
And the chairman indicated he came here at the end of the
S&L issue. I was here in the middle of it and I remember what
that was like as we deregulated the industry, we allowed people
to get into businesses which they had no former experience and
certainly no discipline, as they began to loan money.
And now we find ourselves here with the pension problems
that we have, and in some measure it is a reflection, I think,
of the lack of will by the Congress to do what they are
supposed to do, and that is to ask questions.
Now, having said that, let me point out that I recall when
President Clinton offered his health care plan, that was vetted
from every conceivable angle. People like myself opposed it
because we didn't think that the questions were being answered
in the right way.
The current Congress goes along with everything the
administration says. Never is there a question. We hear time
and again answers from the administration that cause Members of
Congress to swoon in front of them rather than to ask them
about the true problems.
And now we have this issue here in front of us about
pension liability.
And let me specifically speak to the issue of the multi-
employer pension plans.
We have done some things here in the last few years to
address the issue of single employer pension plans. But we
really haven't addressed the multiple employer pension plan.
Would the two witnesses care to speak to those issues?
Mr. Walker. I can speak to it, having been head of the
PBGC. There are two principal kinds of defined benefit plans
that the PBGC insures. One is the single employer pension plan,
which typically is sponsored by a particular company for its
employees and retirees. Another is a multi-employer pension
plan, which typically is sponsored by a trade union. It could
be the Teamsters, it could be other types of unions, and where
the nature of the benefit promised is somewhat different, but
it is a defined benefit promise.
Importantly, the insurable event is different for multi-
employer plans versus single employer plans. For single
employer plans, it is termination. That was the use for LTV,
Bethlehem, and United.
For multi-employer, it is insolvency. In other words, when
the money runs out and you can't pay benefits. There are
significant exposures in the multi-employer plan universe. They
are not likely to be realized as quickly, just like Social
Security. When the trust fund runs to zero, that represents
insolvency. In the case of Social Security today, the program
already has a $4 trillion deficit.
So that is the primary difference.
Mr. Holtz-Eakin. A good opportunity for me to make clear to
the committee that our work focused exclusively on the single
employer plans. That judgment was made because if you look at
the $23 billion--sunk costs in the single employer plans--there
is about a $0.2 billion comparable number for the multi-
employer plans.
So we focused on the bigger problem first.
Mr. Neal. Thank you.
Mr. Chairman, I want to reiterate what I said at the
beginning. I want to thank you for holding this hearing. And I
want to say that whether--the trouble we have here, I think, in
the Congress, whether it is global warming or it is tobacco, it
is really hard to get answers to questions.
And I want to tell you, for those of you who have an
institutional memory here, we hammered witnesses on the S&L
issue, of all political parties. They were dragged--I was on
the Banking Committee at the time, for two painful terms. We
clobbered those witnesses as they came before us regardless of
their political party or their affiliation or who they were
close to. During the Clinton health care plan, we hammered away
at them day after day.
It is the job of the Congress to ask questions and not to
accept everything the administration says. And that is why we
find ourselves now trying to play catch-up with giving a lot of
answers to questions.
So I do thank you sincerely, Mr. Chairman, for holding this
hearing.
Chairman Nussle. Mr. Conaway.
Mr. Conaway. Thank you, gentlemen.
Thank you, Mr. Chairman, I appreciate that.
The reporting requirement that PBGC gets under law versus
what FASB requires obviously are not the same. I do not know
that the FASB disclosures are all that great either. There are
some suggestions that additional information, more information
as to the types of assets within plans and the extent that
companies use their own stock to fund their annual
contributions.
Could you talk to us a little bit about the nature of the
assets and the fiduciary responsibilities that the plan
trustees have of diversifying investments out of their
portfolio?
Mr. Walker. Having been a prior Assistant Secretary of
Labor for ERISA, I had to oversee the fiduciary responsibility
provisions. There are fiduciary responsibility provisions that
relate to all private pension plans. Prudence is one of those.
Diversification in order to minimize the possibility of large
and unexpected losses is an element of this.
For defined benefit pension plans, which we are talking
about here, there is a statutory limitation that employers can
not invest more than 10 percent of the value of the assets in
the plan in qualifying employer securities. But that 10 percent
is determined as of the time that the contribution is made to
the plan, so it could vary from 10 percent, depending upon
market trends.
There are, however, certain types of plans called floor
offset plans where you have a defined benefit plan in
conjunction with the defined contribution plan. By the way,
Enron had one. Under these plans, you can evade that 10 percent
limit in employer stock under current law. I think this needs
to be addressed. It needs to be stopped because it represents
undue exposure for plan participants and beneficiaries and to
the PBGC.
You are making a good point that you just can't look at the
assets and you just can't look at the liabilities and the net
difference. You have to understand the nature of the assets,
the nature of the liabilities and that is why I am saying the
current deficit----
Chairman Nussle. Sorry to interrupt. We are OK. It is the
Senate.
Mr. Walker. We are OK?
Chairman Nussle. I knew this was a hot hearing. I hope we
did not catch on fire. [Laughter.]
You are in a different world.
Mr. Walker. Thank you. OK. On the other side of the Hill,
right? We will not say anymore.
The fact of the matter is, you need to get below the
bottom-line numbers, because it makes a difference as to what
true risk and true volatility are.
Mr. Conaway. As you used Bethlehem Steel and LTV, the
differential between what was being reported as the unfunded,
about 85 percent, versus what actually, that 60 percent.
What role did the plans holding LTV or Bethlehem Steel
stock? Because once the company goes bankrupt, any exposure to
that stock means that you have caused a problem. That
exacerbated the problem.
Do you know off the top of your head?
Mr. Walker. I will have to provide that for the record. The
primary difference was, No. 1., the differences in the interest
rates and No. 2, the fact in the case of LTV or Bethlehem, I
think it was, there were significant shut-down benefits that
popped up overnight that caused the funding level to decline
dramatically.
So primarily interest rates and shut-down benefits. I will
provide the rest for the record.
Mr. Holtz-Eakin. Congressman, I want to note for the
committee again, when we did our work, it was entirely off the
publicly available information that we can get through the 10-K
filings.
It remains an unfinished task to crosswalk our estimates to
the estimates of the PBGC. The confidentiality provisions under
law preclude that quite frankly. I think a policy issue going
forward is the degree to which that confidentiality is an
important part of the way that PBGC should operate.
Mr. Conaway. Mr. Walker, you showed a chart that was
updated all the way through 2002 and made some reference to the
stale date. Why is that information not more readily available?
Mr. Walker. Two reasons. Under current law, people are not
required to file it until, I think, about 7\1/2\ months after
the end of the year. After they file it, it takes a
considerable amount of time for the information to be processed
by the Government.
Historically, the Government has waited until all of the
returns were processed before they provided information
publicly.
So I think there are several issues here. By the way, we
have issued a report on this which I am happy to make available
to you and the other members.
I think you need to look at requiring accelerated
reporting, at least with regard to plans that represent a risk
with regard to their financial condition. I also think we need
to move to electronic reporting, especially for large companies
possibly requiring electronic reporting by large companies.
Certain other government agencies have already done that for
other required reports.
Clearly, the Department of Labor needs to improve their
processes and possibly reconsider how they are processing these
returns, so they don't wait until the end. They also need to
analyze this information more on an installment basis rather
than on a completion basis.
Mr. Conaway. Thank you, gentlemen.
Mr. Chairman, thank you.
Chairman Nussle. Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
And thank you, Mr. Spratt, for requesting this hearing.
Mr. Chairman, I also appreciate your convening the hearing.
Gentlemen, would it be safe and reasonable for us Members
of Congress to assume that the pension benefits of employees
are created basically the same as the pension benefits of
corporate executives?
Mr. Walker. No.
Mr. Moore. Why not?
Mr. Walker. Well, two reasons. One, there are two types of
plans that typically corporate executives have. Many times they
are covered under the defined benefit pension plan that would
be subject to PBGC guarantee limits. Obviously, they have more
exposure if they are, because the maximum benefit guarantee for
PBGC is about $45,000 a year at the normal retirement age.
Therefore, typically, they would have a lot more lucrative
benefits based upon their salary. So they would take more of a
haircut.
Secondly, typically, most corporate executives, especially
for public companies, have non-qualified deferred compensation
plans that are not subject to the Employee Retirement Income
Security Act. They typically provide for very lucrative
benefits, and typically, a vast majority of their benefits are
this way. They may or may not be funded.
They may be subject to additional risk in bankruptcy, but
there are ways to provide funding and security to avoid any
problem in bankruptcy. That is a very controversial topic.
Mr. Moore. And what would those ways be, if you can tell us
briefly, Mr. Walker?
Mr. Walker. Well, there are certain types of tax planning
and trust vehicles that have been used in the past that have,
in some cases, withstood bankruptcy. I would be happy to
provide details for you if you would like.
Mr. Moore. Well, the intent of my question was not to give
further protection to the corporate executives, but to find out
if maybe, if they had additional risk and the same risk that
employers have, that maybe things might change. Any thoughts
there, about how to make that happen?
Mr. Walker. Well, I think there are some people that have
talked about whether and to what extent there should be more of
a mutuality of interest with regard to this risk. I would be
happy to talk to you about that further, because there are some
complicating factors.
I mean, it is one thing if the executives have been there
since the beginning and maybe they were some that made the
promises that they could not deliver on or they decided not to
fund the pension plan and to do something else with the money.
It is another issue if you have somebody who is new
management, who is coming in to try to help save the company,
they weren't part of the problem, and your need to be able to
attract and retain top talent.
So I would be happy to talk to you about it further. But I
think it is a fact and circumstances issue.
Mr. Moore. Thank you, Mr. Walker.
You said to us, go look at the numbers, and they are on a
site or someplace. And you were talking about a $30 trillion
dollar Medicare unfunded liability? Is that correct, sir?
Mr. Walker. Close to $30 trillion.
Mr. Moore. And $4 trillion for Social Security.
Mr. Walker. That is correct.
Mr. Moore. Where do we go look at those numbers?
Mr. Walker. Well, first, they are in the Social Security
and Medicare trustees reports, which come out every year.
Secondly, the number for last year, fiscal 2004, which is
somewhat lower than that, but still staggering, is in the
annual report of the U.S. Government, which is also available
on Treasury's website and our website as well.
Mr. Moore. You also made the statement, I believe, and this
may not be an exact quote but close, I think, they are not
trust funds. Did you say something like that?
Mr. Walker. If you look at ``Webster's Dictionary,'' these
do not qualify as trust funds----
Mr. Moore. I understand that.
Mr. Walker. They are sub-accounts of the general ledger. In
fact, if you look at the financial statements of the U.S.
Government, you will not find a liability equal to the amount
of bonds that are in these trust funds, because the left hand
owes the right hand.
One of the things that I am pushing for is to provide more
transparency over what is going on, because last year, our
deficit really wasn't $412 billion, it was $567 billion,
because we spent every dime of the Social Security surplus.
Mr. Moore. I practiced law for 28 years before I came to
Congress. And in Kansas and I think probably most other states,
there is a requirement that attorneys who have client's funds
in their possession deposit them in a true trust account. And
it is an absolute no-no to touch those funds, because you can
be prosecuted perhaps and disbarred for doing that.
Would there be any benefit to the U.S. Government having a
true trust fund for deposit of Social Security monies that are
later to be paid out for benefits?
Mr. Walker. I think there are two issues. One, even if you
had a true trust fund, if you are going to invest the same way
that you are investing right now, I am not sure that would
really change anything.
Mr. Moore. Of course, we are not investing right now, we
are spending, are we not, on----
Mr. Walker. Well, we are spending it----
Mr. Moore (continuing). A lot of other things, right?
Mr. Walker. We are spending every dime of the Social
Security surplus on other government expenses. We are replacing
it with a non-readily marketable bond backed by the full faith
and credit of the U.S. Government, guaranteed as to principal
and interest, but it is only as good as the ability of the
Government to tax, to cut other spending, or to go out and
borrow, typically from foreigners, in order to be able to fund
our deficits and debt.
Mr. Moore. Thank you, sir.
Chairman Nussle. Mr. Ryan.
Mr. Ryan. A couple of questions I wanted to ask already
were asked, such as Mr. Chocola's on accrual accounting.
Let me ask you about the difference between multi-employer
pension plans and single employer pension plans. Mr. Walker, I
think with multi-employer pension plans, the risk is spread to
the rest of the employers in the pool, so there is another line
of risk exposure away from the Government with respect to multi
versus single, correct?
Mr. Walker. That is correct.
Mr. Ryan. And so looking at the provisions we are facing
within this Congress on multi-employer pension plans, do you
think--and this is a question for both of you--that we can,
through reforms, transparency, smoothing, all these other
things--and you have seen the proposals up here--that we can
reform multi-employer pension plans sufficiently in this
Congress?
We are looking at reconciliation. What are the first things
first that we do? It appears that we can't fully fix the
single-employer problem. Can we, in your estimation, fully fix
the multi-employer problem?
Mr. Walker. Well, candidly, it is my understanding, Mr.
Ryan, that the administration's proposals do not go to multi-
employer plans, and I am not familiar if there are legislative
proposals up here that do.
Mr. Ryan. There are, and they are from multiple sources. I
think the Teamsters have one for the red zone, the food
distributors for the yellow zone.
You know, there are a lot of groups that are involved in
multi-employer pension plans who have come up with proposals.
Ed and Labor, not a committee I serve on, is doing hearings on
these things.
So you haven't had a chance to look at these various multi-
employer pension proposals?
Mr. Walker. I haven't, but I will be happy to take a look
at it.
Mr. Ryan. Yes, I would love to hear your opinion as to
whether or not those cover the job of fixing the plan.
Doug, have you taken a look at any of these solutions?
Mr. Holtz-Eakin. We haven't looked at those. The one
distinguishing difference here is the degree to which you can
get additional monitoring from the other firms in a multi-
employer plan.
And so if you can make that monitoring more effective, you
can get a lot of bang for the buck out of things that do not
have a lot of----
Mr. Ryan. Because they have an incentive to make sure--so
more transparency is clearly a great starting point for the
multis.
On the singles, should I take away from this testimony,
from both of you, that at first blush, the premium increase is
just the first no-brainer? Then we are going to have to look at
transparency, other things like that. And given where we are
with respect to reconciliation, that is the best place to
start?
Mr. Holtz-Eakin. The fixed premium is certainly the place
to start. Thinking hard about what you want the variable
premium to do and whether you want it to address underfunding
and risk and how quickly you move that is a bit harder.
Mr. Ryan. OK, let us go to accrual quickly. I got the
impression from the answer to Mr. Chocola's questioning that,
Mr. Walker, you think it is right and proper that we do full
accrual accounting of all the assets and liabilitieson the
books.
Doug, I got from you that you think it is just a tough
computation to make, especially when you are talking about
health care.
Mr. Holtz-Eakin. I also think it is different. I mean, it
reflects an attempt to transfer private sector accounting into
the Government, and government is different. It has the power
to tax. In the end, government programs are funded up to the
point of economic rationale. You can tax the resources and
provide them for the Government budget.
There is no private entity that has a comparable power, who
can print money as a government can.
So I am nervous about simply carbon-copying private sector
reporting and budgeting into the government sector. They are
different.
Mr. Ryan. Actually, I think that is a very good argument
when applied to Social Security, which is when you price
benefit guarantees, the cost of pricing a benefit guarantee
would be theoretically lower for the Federal Government because
it has the power to tax any given year than versus pricing,
say, a benefit guarantee in the private sector. Would not the
same argument apply?
Mr. Holtz-Eakin. In those circumstances where the
Government has the ability to pool across a greater set of
risks, it will do better than the private sector. And what you
want to do is look for those opportunities where the Government
has a comparative advantage in risk spreading.
Mr. Ryan. So you would agree on both sides, the Social
Security side of the ledger as well?
Mr. Holtz-Eakin. Not necessarily on all Social Security
matters. You and I have been there.
Mr. Ryan. That is why I wanted to bait you into that.
Mr. Walker. If I can, Mr. Ryan, there are two issues. One
is the issue of financial statements, and we do have accrual
accounting for financial statements. However, right now the
only thing that is deemed to be a liability on Social Security
and Medicare is due and unpaid benefits.
We do disclose the discounted present value numbers of the
difference between promised benefits and funded benefits, that
is a $4 trillion number for Social Security and roughly a $30
trillion number for Medicare.
Mr. Ryan. Is the 30 a 75-year number?
Mr. Walker. It is a 75-year number. We do disclose that. It
is not deemed to be a liability. I would debate whether or not
it is a liability, because of some of the fundamental
differences between a pension plan and social insurance
program.
The other side of the coin--but it needs more transparency.
At the same point in time, the other side of the coin is,
what do you do for budget purposes? So for financial
statements, we need accrual concepts. The debate is whether or
not it is a liability. We need more transparency and enhanced
reporting in any event.
On the budget side, it is different.
Mr. Ryan. But you both agree that accrual is appropriate
when we are talking about single employer----
Mr. Walker. Well, they already have it. They are subject to
generally acceptable accounting principles. For example, PBGC's
$23.3 billion deficit at September 30, 2004, include United
Airlines, which did not terminate until this year.
Now, why did it include United Airlines? Because under
generally accepted accounting principles, if it is
identifiable, probable and estimatable, you have to book it as
a liability on an accrual basis.
Interestingly, if you end up increasing PBGC's premiums,
that will help the Federal budget. That will help PBGC in the
short term. But they will still have a huge hole. So it might
make them look like they are better off than they are, but in
reality they are still in a huge whole.
Mr. Ryan. And there is some peril to that.
What is the infinite horizon number on Medicare trustees? I
don't know off the top of my head.
Mr. Walker. I remember Social Security's number is over $10
trillion. I do not remember the Medicare number.
Mr. Ryan. You don't know Medicare?
Mr. Walker. Not off the top of my head but I will be happy
to provide it for the record.
Mr. Ryan. Thanks.
Chairman Nussle. Mr. Edwards.
Mr. Edwards. Mr. Chairman, let me first thank you for
holding this meeting.
Mr. Spratt, for asking for it.
I think as an institution, we are good sometimes at
addressing immediate crises. We are reactive, though, as an
institution. We are not very good at trying to prevent crises
10, 20 years down the line. I think it is important that you
start the first process, educating Members of Congress that
there is a serious problem here.
General Walker, I guess this is a request, perhaps, as you
play a leadership role in addressing this problem, I hope you
will address the issue of corporate responsibility and
fairness.
I think our capitalist system, which is the greatest
capitalist system in the history of the world, depends on
trust, as you know better than I do.
And while the key issue here is protecting the pension
benefits of workers and not exposing taxpayers to too much
liability, the fact is that if corporate CEOs are getting
golden parachutes, the very same CEOs who in many cases are
responsible for making the poor management decisions that drove
their corporations into bankruptcy, they are being protected
with golden parachutes by boards, and workers are getting the
shaft and losing their pensions altogether, a great percentage
of them, you are really going to lose trust in this system.
And I hope that aspect of it, while the numbers of
corporate execs may be limited, I think it is a huge issue that
Mr. Moore dealt with. And I hope somehow we deal with that.
And I know you have to be careful. You don't want to punish
corporate CEO and executives that were not responsible for
driving a company into bankruptcy and you don't want to set up
kinds of disincentives to corporate executives so that none of
them would ever want to set up a defined benefit plan.
But within those limitations, I hope that issue is seen as
not just a minor side issue, but an important part of the
public's confidence in our system.
Let me ask this. I haven't looked carefully at the status
of General Motors, but I understand their bonds are at junk
bond level now. If tomorrow--let us be clear, General Motors is
not going to go bankrupt tomorrow--but if General Motors would
go bankrupt, what would be the implications on PBGC of that, in
terms of dollar exposure? If you were to assume the Federal
Government would make the benefits, pension benefits of their
employees.
Mr. Holtz-Eakin. I think the honest answer is: We don't
know. The PBGC knows, but they can't tell us. I mean, the
filings are confidential. It is a substantial pension risk. It
is a very big number.
Mr. Edwards. We can generally--we could probably do some
decent estimating. You have to do that all the time as an
economist, and I respect that. I assume you could estimate the
average worker's pension benefit, given an average expected
life expectancy, would cost so much. And if GM went under, I
mean, are we talking about $50 billion, $1 trillion, at least
just to put it in perspective?
Mr. Holtz-Eakin. We can produce a rough estimate.
Mr. Edwards. OK.
Mr. Walker. I think that what one could do, and I will be
happy to provide something for the record, is to look at the
10-K for General Motors and possibly get a sense as to what the
potential magnitude is.
I don't know the number off the top of my head. It is my
understanding that if that were to happen, it would be a
substantial loss, possibly the largest in the history of the
agency.
Mr. Ryan. Will the gentleman yield, just for a quick
clarification?
Mr. Edwards. Be glad to.
Mr. Ryan. Is it not true that General Motors is not
underfunded, and they floated $18 billion of bonds about 2
years, and they are not declared an underfunded plan? Is that
not the case?
Mr. Holtz-Eakin. I think that is right. That is what we are
going to check.
Mr. Ryan. Yes. But Ford and Chrysler are lower than GM. GM
does not have an underfunded pension plan, to my understanding.
Mr. Holtz-Eakin. Yes. And I am not familiar with the nature
of their investments.
Mr. Ryan. They are my larger----
Mr. Holtz-Eakin. Right. OK. OK.
Mr. Edwards. Well, we will follow up on that issue.
Let me ask this.
Dr. Holtz-Eakin, when we reduced the corporate tax rate in
the last several years, what was it reduced from, and to what
level today?
Mr. Holtz-Eakin. It is 35 percent now. It has been much
higher in the past. It is now 34 percent for manufacturers.
Mr. Edwards. What role did the economic implications, if
you were to take those companies that your own report says many
of the underfunded plans are sponsored by financially healthy
firms. What if we deferred that tax cut until those pension
investment plans for those corporations were considered
adequate enough to----
Mr. Holtz-Eakin. I don't know off the top of my head. I
would be happy to go through that to the best of our ability
and get back to you.
Mr. Edwards. OK. Final question: Has anybody looked at the
270 companies that have underfunding within $50 million as of
2002, what kind of pension plan that corporate executives in
those 270 companies have? Has anybody looked at that?
Mr. Holtz-Eakin. We haven't.
Have you?
Mr. Walker. We haven't looked at that.
I think one has to be careful about General Motors, because
the fact of the matter is, you have to look at the nature of
their plan. If their plans have shutdown benefits, which it is
very possible that they could, then they could look fine from
the standpoint of the 10-K, because they are not considering
the shutdowns.
But there could be real problems if in fact they actually
terminate and there are huge benefits that pop up overnight.
We can't take a whole lot of comfort in the 10-K numbers.
You have to look below the numbers. You have to look at the
nature of the assets. You have to look at the nature of the
plan and the nature of the benefit obligations to truly get a
true sense as to what the real exposure is.
Mr. Edwards. My time is up, but I would just hope someone
could take a look at that in a broad brush figure, just to get
a sense of what the numbers would be.
Chairman Nussle. Mr. Cooper.
Mr. Cooper. Thank you, Mr. Chairman.
Thank you, Mr. Spratt, for requesting this hearing.
As always, thank the witnesses. I appreciate your
leadership on these issues, and even more so on the larger
deficit and debt issues.
I would like to reiterate a comment made at the outset of
this hearing, that as bad as these problems are with PBGC, they
are relatively small set of problems in comparison with the
larger deficit and debt issues that we face.
And I hope that all our colleagues will take it to heart,
some of the warnings particularly David Walker has made,
because the chart that you showed at the outset of the hearing,
when by 2040 it will take all government revenues just to
service the debt and there will be very little, if any, money
left over for national defense or Social Security or Medicare
or anything, clearly should illustrate we are on the wrong
path.
But this Congress is not deviating from that wrong path. In
fact, we are probably accelerating, because I think General
Walker has said that, I think this is an exact quote:
``Arguably, 2004 was the worst year in American fiscal
history,'' because we promised $13 trillion worth of stuff that
we aren't paying for.
Eight trillion dollars of that was in one bill, the
Medicare drug bill. And that bill, as I recall from the last
session, has almost a billion in funding to educate Americans
about the bill and transition into it and things like that.
Poor General Walker has hardly any budget to tell people
about the dangers posed by promising $8 trillion in one piece
of legislation that is not paid for.
So if we put this hearing in perspective, these problems
are grave, but not nearly as grave as the larger problems. And
I would hope we could have more hearings on the larger
problems.
And with the chairman's indulgence, perhaps we can do that.
Very few issues can shake a society to its foundations, but
I think this is one. As we fly back and forth to Washington in
airports, we are approached by dozens of airport workers,
scared, because they are afraid their airline is going to
declare bankruptcy, and they don't really know what PBGC will
or will not do for them. Upper income folks over $45,000 are
particularly concerned.
But is it not true--my understanding is that an employee
who works for what they thought was a good American company,
works for 20 or 30 years, has a defined benefit plan, that
should that company go bankrupt, that employee, despite a
lifetime of work and hard service is just an unsecured creditor
in the bankruptcy proceedings. So they would come after a long
line of secured creditors and others who would have a prior
claim on the assets of that company.
Is that a correct understanding?
Mr. Holtz-Eakin. I think the crucial issue is where does
the PBGC stand in line in bankruptcy. And indeed, they don't
have any preferred status in bankruptcy. And as a result,
cannot claim assets and other resources to honor the benefit.
Mr. Cooper. With a woefully underfunded, underprepared
PBGC, they are going to start looking to us, the U.S. Congress
and to the American taxpayer almost immediately.
Because they thought they were already part of an ownership
society. They thought they already owned their pension. They
thought it was due them.
And these people are waking up and suddenly finding that
their entire retirement plan is possibly shaken, if not
destroyed.
Mr. Walker. Mr. Cooper, Doug is correct in saying that the
issue is not about the individual participants. If the plan
terminates, is underfunded, and is guaranteed by PBGC, then the
PBGC stands in line.
A vast majority of their claims typically are unsecured
claims. There are certain circumstances in which they could
have secured or priority claims, but those are generally the
exception rather than the rule.
Therefore, that is why it is important not just to think
about this as a PBGC issue, there are real losses imposed on
participants, even if PBGC steps in and even if PBGC is
adequately funded for today and tomorrow.
Mr. Cooper. If they were listening to this hearing, they
would have heard already that these multi-employer plans are
safer, because there at least you have multiple managements
watching the store.
They would have also heard that a lot of our CEOs have made
sure that they were taken care of through nonqualified plans,
so they don't have to worry about PBGC or anything. Their plan
is funded and safe and removed from bankruptcy and taken care
of.
So the average poor worker, who all they have done is do a
good job at their job their entire life would have to feel a
little worried at this point.
And they realize theirs is a single employer plan, so there
hasn't been that level of safeguard. The PBGC is underfunded.
Their boss or bosses have taken care of themselves and really
probably don't care in terms of their own financial interests.
That seems to be a society in which it is more dog eat dog than
the Golden Rule.
Mr. Walker. Excuse me, I think we have to be careful, a
significant majority of sponsors of single employer defined
benefit plans are responsible and a majority of the plans are
well-funded.
Regarding multi-employer plans, I think we have to be
careful, because they are not necessarily better off. It is
individual facts and circumstances.
There are troubled multi-employer plans too.
Mr. Cooper. I would agree. Most plans are properly run. But
if you are in the airline industry or the steel industry or
some of these other industries, you are likely to be extremely
concerned.
And I worry that our government looks so out of touch. If
we can't even get data that is more than 3 years old, we look
clueless and hopeless in trying to protect people and their
earned benefits.
So this is the situation.
I appreciate your testimony. I see my time has expired. But
this should be an urgent matter, not as big as the overall debt
crisis that we face, but an urgent matter for this Congress to
face up to.
I thank the gentleman.
Chairman Nussle. Mr. Case.
Mr. Case. Thank you.
We are all taking off on Mr. Cooper's comments about going
through airports. I am married to a United Airlines flight
attendant, who used to be a Pan American flight attendant. That
is called a double PBGC whammy. Not only do I not want to go
through airports nowadays, I don't even want to go home.
[Laughter.]
Let me ask you a bigger picture question, because I think
we obviously have a problem, a looming crisis. And one more
large bankruptcy is going to turn it into a full-blown crisis.
I think it is important for us to understand the
generational extent of the problem. Let me make a statement and
get your reaction to it. In the next 25 to 50 years, are we
going to have a substantial population of defined benefit
plans? Because it strikes me that in the big picture, they are
moving toward some form of obsolescence.
I am talking about private plans, by the way. State and
county governments and the Federal Government--well, the
Federal Government is pretty much out of it at this point, but
State and county governments are still in the defined benefit
arena, and they can figure that out, that doesn't really affect
us.
But in the private sector, are we looking at getting
through a bubble here, a 25-year bubble? I don't know the
figures about whether new companies or old companies are
creating new defined benefit plans, or whether they are
primarily trying to shift the risk, the overall risk, over to
the employees or come up with a different program that will
somehow yield really the defined contribution model being the
pension model, if we have that model at all, from a private
employment perspective.
Is there any anecdotal or empirical evidence that that is
happening?
Mr. Holtz-Eakin. Well, there is lots of evidence on trends.
The defined benefit plan used to be the preferred model. But a
greater fraction of the labor force is now covered by defined
contribution plans than defined benefit plans. So certainly as
a fraction of workers, defined benefit plans are going down,
defined contribution plans are going up.
In terms of absolute numbers, there are more workers
covered than ever by defined benefit plans.
Defined benefit plans will be an important part of the
landscape for quite a while to come. Even if they diminish as a
fraction of the total.
Mr. Walker. I differ somewhat on this. First, my wife is a
Delta Airlines retired flight attendant, so I feel your pain.
Mr. Case. Condolences.
Mr. Walker. I haven't felt it yet, but we may in the
future.
Defined benefit plans have been declining in number. The
number of participants covered in defined benefit plans are
such that more and more represent retirees, rather than
actives.
Thirdly, the only types of defined benefit plans that have
really showed any life, as far as creating them, are so-called
hybrid plans, that look more like defined contribution plans,
but they provide some type of a defined promise, like cash
balance plans.
One of the reasons is because when the Congress imposed the
reversion tax, in other words, when sponsors terminate their
plans, take out excess money, when they are well-funded, they
have to pay excise taxes on that. As a result a lot of
sponsors, rather than going from a defined benefit plan to a
defined contribution plan, which is clearly where the growth is
in the private sector and it is likely to stay for a number of
years for a variety of reasons, many went to a hybrid plan as a
way that they could move toward the defined contribution world,
have potentially less volatility and uncertainty with regard to
their risk, and be able to obtain the economic benefit of the
surplus without having to pay excise taxes.
I think it is highly unlikely that the traditional defined
benefit plan will resurge any time in the near future, at
least.
Mr. Case. Let me ask you, from a perspective of foreign
competition, if you know, when our companies go out there and
try and compete in the world with a defined benefit plan, are
they at a distinct competitive disadvantage at that point,
because I assume that it is true.
I don't really know what is happening in China, for
example, in terms of private pension plans. But it would seem
to me that if the trend here over time is that the competition
in increasingly from China, especially in classic defined
benefit plan country like manufacturing, that you would see the
companies of our country in manufacturing evolve away from
defined benefit plans because it is just simply uncompetitive
when they look overseas at a place like China.
Mr. Holtz-Eakin. I think it is useful to do that in two
steps. Step one is to determine the nature of overall
compensation relative to the productivity of the workers? That
determines fundamental competitiveness.
And pensions are part of that compensation. And the issue
with the defined benefit plans and the PBGC is, in those
circumstances, whether at a firm level or at an industry level
or an economy level, competitiveness changes and compensation
needs to be restructured, i.e., you have to change the way you
do business.
How can past promises be preserved for the future? That is
the nature of the insurance, because you will never be able to
fully anticipate whether today's compensation bargain is the
right one for tomorrow.
But given these structures, employees have done the work.
You have promised the compensation. You have to somehow either
put the resources aside or buy insurance to make sure that they
get paid for their past labor. And so you want to break the
question of competitiveness between total compensation and the
competitiveness that that delivers--versus assuring that the
commitments of the past are honored.
Those are two different problems.
Mr. Walker. The biggest competitive challenge that we face
is health care, by far. That is truly a competitive
disadvantage.
Secondly, if you look at the nature of past losses and
exposure, in the defined benefit system to the PBGC and the
planned participants and beneficiaries, they are concentrated
overwhelmingly in industries that have one of two
characteristics--number one, increasing global competition, and
number two, domestic deregulation.
Those are where a vast majority of the losses are.
Mr. Case. Thank you.
Chairman Nussle. Mr. Davis.
Mr. Davis. Thank you, Mr. Chairman.
General, Mr. Holtz-Eakin, welcome to you today.
You were saying, General Walker, that your belief is that
the overwhelming majority of corporate actors are responsible
in this area and that the overwhelming majority of companies
have made the appropriate decisions in terms of contributing to
their pension plans.
I would contrast that a little bit with some observations
that I saw in The Washington Post a few days ago, and you may
or may not want to comment on the veracity of these statements.
There was an observation from the GAO that said that
because of the rules and the requirements as to the
contributions, that over 60 percent of the largest companies
between 1995 and 2002 did not make adequate new contributions
to their plans.
The Republican chairman of the Senate Finance Committee,
Senator Grassley, bemoaned the fact that, as he put it, ``the
rules themselves were full of very serious holes.''
As I listen to this argument, I have this image in my mind
of the bankruptcy debate that we had just a couple of months
ago. And in interest of full disclosure, I voted for the
bankruptcy bill because I tend to prefer bright-line standards
over no standards.
But during that debate over bankruptcy, there were a lot of
people on, frankly, both sides of the aisle, on my side, on the
chairman's side, who kept using the phrase ``personal
responsibility'' over and over again.
And it sounds great, this idea of personal responsibility,
this idea that people pay their bills, which is better known as
another way of keeping your promises, because when you enter an
arrangement with a creditor and promise to pay them, that is a
promise, in effect.
And we got very outraged about the idea that, well, people
making $45,000 a year were shirking their duties and they were
trying to get in Chapter 7 when they didn't need to be, and we
got all bent out of shape about all of these middle-class
people walking around who just didn't want to pay their bills,
weren't being responsible.
It seems pretty clear to me that we are talking about
another kind of moral responsibility here.
When a company enters an arrangement with an employee and
provides a pension, that strikes me that, that is as moral a
promise as the one a creditor makes with a debtor, and that--
vice versa--and that ultimately there are companies in America,
some of them with the excuse of hard times, some of them
without that excuse, who are simply taking advantage of fairly
soft rules and not adequately funding their plan.
And I am reminded, frankly, of something that the 42d
President of the United States, Bill Clinton, used to say a
lot. He used to, when he was making my party one that
identified with personal responsibility again, he would use the
phrase that for all of our talk about personal responsibility,
we shouldn't lose sight of the fact that the greatest flight
from responsibility in this country in the 1980s and 1990s came
at the top and not the bottom of the economic sphere.
And I would submit that, frankly, that is where we are
again. Frankly, the bankruptcy bill that we passed and that I
voted for should have given priority to the PBGC.
Frankly, we ought to be finding ways, across the aisle, to
incentivize companies to do the right things for their
employees. We ought to be doing things to incentivize them to
contribute to their pension plans.
And we shouldn't just be so cavalier about this idea that
when companies get in trouble the first people they ask to
sacrifice are the people who are earning their profits for them
every single day.
I think that this is a matter of moral responsibility. And
would either of you care to comment on that proposition?
Mr. Walker. Well, let me comment on the GAO report, because
I reviewed it, and it is referenced in my testimony.
Basically, overall funding levels have deteriorated during
the period 1995 to 2002, but most plans were well-funded.
Here is what happens. When companies start to get into
trouble, they start using the rules such that they will do what
they are minimally required to do under the law, rather than
what is right.
My personal view is, is that people ought to not make
promises that they can't deliver on and that the law should be
structured to maximize the chance that they are held
responsible and accountable to do that in the vast majority of
circumstances.
But the simple fact of the matter is, history has shown
that when people get in trouble, pensions are not a priority,
they do the minimum, and therefore there is a put option
exercised on the PBGC which ultimately represents a contingent
liability to the taxpayer.
Last thing. I have been very outspoken on the need for
corporate governance reform, and on the need for additional
transparency and accountability in the private sector. GAO and
I were very actively involved in Sarbanes-Oxley and other
issues, and we will continue to be.
Mr. Davis. Well, I appreciate that.
If I can just wrap up, Mr. Chairman, in just 10 seconds.
I mean, frankly, all the people in my party who are sitting
around looking for a big idea for us to talk about, this ought
to be one of our big ideas, how we keep our commitment to
employees every day and how we stop companies from shirking
their responsibilities by taking advantage of loopholes.
If it is good enough for people who are filing bankruptcy--
you know, sometimes I wish that we cared as much about the
people who vote for us, as we do the people who write us
checks.
Chairman Nussle. Ms. Schwartz.
Ms. Schwartz. Thank you, Mr. Chairman. And thank you also
for this hearing.
And I appreciate the most recent questions, and in
particular I know there was a lot of discussion about,
generally, transparency and knowing more about what is going
on.
But I am really interested in that, because of Mr. Davis
and Mr. Cooper asking very much about the employee, about the
plan participants. And I know there has been a lot of
discussion about personal responsibility, about individual
employees being able to take on pretty important decisions
about how they invest and save for the future.
I do not agree with the president's plan to privatize
Social Security. But I do agree that Americans should have both
flexibility and ability to make retirement investment decisions
and be given more flexibility and information to do that.
We are now faced with the whole concern you have about
pensions and about their not being there. And you have been
calling for more information to us, Congress, to you, to just
make sure we don't end up with too many underfunded pensions.
But even looking at the president's proposal and some of
his ideas, which I think some of them are good ones, how much
information is going to be available to employees along the
way? To what degree do you think they ought to know and have
access to information in an understandable way?
Everyone can say, look, stockholders, shareholders,
employees, can go to annual meetings and they can look through
all that information. But I think all of us who have been
employees, our eyes glaze over when we have our 5-minute
meeting with the human resources person when we first get
hired, and we never see them again, until we retire.
And then we say, ``Well what did the fine print say?'' And
there are a lot of years in between.
And how can we in an ongoing way provide information to
employees or require companies to provide that information to
employees about the status of their pension plans, changes that
have been made, the degree to which they are funded or
unfunded,even the concern today is, they have been funded
adequately, but it has not been doing well, so that the value
has gone down and maybe appropriately the company says I am
going to take some money out of there, put it in there, try and
invest in the company. It will do better. Employees will
ultimately do better and I will be able to pay back the pension
plan.
It sounds a little bit like what the Government is doing
with some Social Security trust funds.
But it is maybe not an outrageous notion, except when it
doesn't work. And when in fact, they are paying far too little
in and it ends up in a disaster, which then the taxpayers have
to pay and employees don't get all that they should.
So my question is, what can we and should we be doing to
require companies to be more straightforward with their
employees and provide information in a really consumer friendly
way, if you could say that, and encourage employees to take all
the personal responsibility they can to understand the reality
that they are in? So not just dealing with the fear that
everybody has about what next, but what can actually be done to
help the employee be a part of the solution, if they can be at
all?
Mr. Walker. I think it is important to note that under
current law, plan participants and beneficiaries are required
to get a summary annual report. They have the opportunity to
receive the Form 5500, which is the annual report that is filed
with the Government. They obviously have an opportunity to
look, if it is a public company, at the 10-K.
I think the problem is is that some of the information that
they are giving is not in a very useful and usable format. It
is provided as part of a tremendous amount of information and
people don't really understand what is important.
I think one of the answers is, you need to give them more
timely, more market-based information and in a way that they
are more likely to pay attention to it, understand about it,
and care about it.
I think that should be a key element of any comprehensive
reform proposal.
Ms. Schwartz. OK. You need to be more specific about that
as we go forward, about what that would mean.
I guess the next question would be, do you think that they
should be able to take any action--I am not sure what that
would be. But what happens when they get all this information
and they find out that it is going to be pretty tough going
forward? What then do they do about it?
Mr. Walker. Well, it depends. I mean, the fact of the
matter is, if it is a collectively bargained plan, and if they
knew more about it, employees could end up bringing more
pressure on those who represent them to try to be able to make
sure that the plan is adequately funded.
If it is not a collectively bargained plan, employees could
bring more pressure on management in order to try to make sure
that people are not just avoiding the problems.
Transparency and sunshine is a powerful force. A lot of bad
things can happen if they are done in the dark. So I think we
need to include this.
Ms. Schwartz. OK. I appreciate that. And again, the
information be in a really consumer-usable way is really the
point. So thank you very much.
Thank you, Mr. Chairman.
Chairman Nussle. I thank the gentlelady.
Thank you very much, both of you, for your testimony today.
This is an opportunity to be in some ways a canary in the mine
shaft. And we hope that the warnings will be taken by our
colleagues on other committees.
We will certainly make sure that they understand what
happened on some of the testimony here today, and hopefully we
can begin to use the reconciliation process this year to usher
through some new proposals with regard to PBGC to help
alleviate the challenges that are obviously upcoming, from your
testimony.
Mr. Walker.
Mr. Walker. One quick thing, Mr. Chairman.
I just want to refamiliarize you and the other members on
the committee with our ``21st Century Challenges'' report.
Several of the members, including yourself as chair, noted that
this is a subset of a much bigger problem.
There are 202 illustrative questions that need to be asked
and answered about the base of the Federal Government in here.
One of them relates to PBGC.
This is an important issue, but it is a subset of a much
bigger challenge. We look forward to working with you and
others to try to address them in the future.
Thank you.
Chairman Nussle. I thank you.
And without anything further to come before the committee,
we will stand adjourned.
[Whereupon, at 11:30 a.m., the committee was adjourned.]