The Employee Retirement Income Security Act of 1974 (ERISA), and  several amendments to the law since its passage, established minimum  funding requirements for sponsors of pension plans in order to try to  ensure that plans have enough assets to pay promised benefits. Under ERISA, the termination  of a single-employer DB plan may result in an insurance claim with the  single-employer program if the plan has insufficient assets to pay all  benefits accrued under the plan up to the date of plan termination. The recent decline of PBGC’s single-employer program has occurred in the  context of the long-term stagnation of the DB system. Furthermore, because of  leeway in the actuarial methodology and assumptions sponsors can use to  measure plan assets and liabilities, underfunding may actually have been  more severe and widespread than reported at the end of the period. 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. The Bethlehem Steel  Corporation in 2002 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. Most Sponsors of Large Plans Did Not Make Annual Cash Contributions, but Satisfied Funding Requirements through Use of Accounting Credits

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. Even  though the plan no longer had this $1 million in assets, the sponsor could  still use that credit balance (plus interest on the credit balance) to reduce  this year’s contribution to the plan. The interaction between the FFL rule and the annual maximum tax- deductible contribution also has implications on the amount that plan  sponsors can contribute. 3). Very Few Sponsors of Underfunded Large Plans Paid an AFC from 1995 to 2002

Funding rules dictate that a sponsor of a plan with more than 100  participants in which the plan’s actuarial value of assets fall below 90  percent of liabilities, measured using the highest allowable interest rate,  may be liable for an AFC in that year. All of these plans were  assessed an AFC more than once. Large Plans’ Sponsors’ Credit Ratings Appear Related to Certain Funding Behavior and Represent Risk to PBGC

The recent funding experiences of large plans, especially those sponsored  by financially weak firms, illustrate the limited effectiveness of certain  current funding rules and represent a potentially large implicit financial  risk to PBGC. Plans sponsored by speculative grade- rated firms were also more likely to be underfunded. PBGC’s claims experience shows that financially weak plans have been a  source of substantial claims. Conclusions

Widely reported recent large plan terminations by bankrupt sponsors and  the financial consequences for PBGC have pushed pension reform into the  spotlight of national concern. Our analysis here suggests that certain  aspects of the funding rules have contributed to the general underfunding  of pensions and, indirectly, to PBGC’s recent financial difficulties. Further, the rules appear to lack strong mechanisms  to compel sponsors to make regular contributions to their plans, even  those that are underfunded or subject to an AFC. Ideally, effective reform would  improve the accuracy of plan asset and liability measurement while  minimizing complexity and maintaining contribution flexibility;   develop a PBGC insurance premium structure that charges sponsors fairly,  based on the risk their plans pose to PBGC, and provides incentives for  sponsors to fund plans adequately;    address the issue of severely underfunded plans making lump-sum  distributions;  resolve outstanding controversies concerning cash balance and other  hybrid plans by safeguarding the benefits of workers regardless of age;  and improve plan information transparency for PBGC, plan participants,  unions, and investors in a manner that does not add considerable burden  to plan sponsors. As I noted in my opening remarks, PBGC’s challenges parallel the  challenges facing our Social Security system. Further,  timely action to address both private pension and Social Security reform is  needed. However, consideration must be given to the interactive effects of  any such reforms and how they contribute to addressing our nation’s large  and growing fiscal challenge, key demographic, economic and workforce  trends, and the economic security of Americans in their retirement years. This is a work of the U.S. government and is not subject to copyright protection in the  United States.
Why GAO Did This Study

This testimony discusses our recent report on the rules that govern the funding of defined benefit (DB) plans and the implications of those rules for the problems facing the Pension Benefit Guaranty Corporation (PBGC) and the DB pension system generally. In recent years, the PBGC has encountered serious financial difficulties. Prominent companies, such as Bethlehem Steel, U.S. Airways, and United Airlines, have terminated their pension plans with severe gaps between the assets these plans held and the pension promises these plan sponsors made to their employees and retirees. These terminations, and other unfavorable market conditions, have created large losses for PBGC's single-employer insurance program--the federal program that insures certain benefits of the more than 34 million participants in over 29,000 plans. The single-employer program has gone from a $9.7 billion accumulated surplus at the end of fiscal year 2000 to a $23.3 billion accumulated deficit as of September 2004, including a $12.1 billion loss for fiscal year 2004. In addition, financially weak companies sponsored DB plans with a combined $96 billion of underfunding as of September 2004, up from $35 billion as of 2 years earlier. Because PBGC guarantees participant benefits, there is concern that the expected continued termination of large plans by bankrupt sponsors will push the program more quickly into insolvency, generating pressure on the Congress, and ultimately the taxpayers, to provide financial assistance to PBGC and pension participants. Given these concerns, we placed the PBGC's single-employer program on GAO's high-risk list of agencies and programs that need broad-based transformations to address major challenges. In past reports, we identified several categories of reform that the Congress might consider to strengthen the program over the long term. We concluded that the Congress should consider comprehensive reform measures to reduce the risks to the program's long-term financial viability and thus enhance the retirement income security of American workers and retirees. More broadly, pension reform represents a real opportunity to address part of our long-term fiscal problems and reconfigure our retirement security systems to bring them into the 21st century. This opportunity has many related pieces: addressing our nation's large and growing long-term fiscal gap; deciding on the appropriate role and size of the federal government--and how to finance that government--and bringing the wide array of federal activities into line with today's world. 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. We therefore must fundamentally reexamine major spending and tax policies and priorities in an effort to recapture our fiscal flexibility and ensure that our government can respond to a range of current and emerging security, social, economic, and environmental changes and challenges. The PBGC's situation is an excellent example of the need for the Congress to reconsider the role of government organizations, programs, and policies in light of changes that have occurred since PBGC's establishment in 1974.

What GAO Found

Our recent work on DB pension funding rules provides important insights in understanding the problems facing PBGC and the DB system. To summarize our findings, while pension funding rules are intended to ensure that plans have sufficient assets to pay promised benefit to plan participants, significant vulnerabilities exist. Although from 1995 to 2002 most of the 100 largest DB plans annually had assets that exceeded their current liabilities, by 2002 over half of the 100 largest plans were underfunded, and almost one-fourth of plans were less than 90 percent funded. Further, because of leeway in the actuarial methodology and assumptions that sponsors may use to measure plan assets and liabilities, underfunding may actually have been more severe and widespread than reported. Additionally, on average over 60 percent of sponsors of these plans made no annual cash contributions to their plans. One key reason for this is that the funding rules allow a sponsor to satisfy minimum funding requirements without necessarily making a cash contribution each year, even though the plan may be underfunded. Further, very few sponsors of underfunded plans were required to pay an additional funding charge (AFC), a funding mechanism designed to reduce severe plan underfunding. Finally, our analysis confirms the notion that plans sponsored by financially weak firms pose a particular risk to PBGC, as these plans were generally more likely to be underfunded, to be subject to an additional funding charge, and to use assumptions to minimize or avoid cash contributions than plans sponsored by stronger firms.