Remarks of Bradley D. Belt
Executive Director
Pension Benefit Guaranty Corporation
to the U.S. Chamber of Commerce
Thank you. I am grateful to the Chamber for the opportunity to talk to you today on the critically important and timely issue of pension reform. I understand that Chairman Boehner kicked off your discussion of this topic two weeks ago, and I am honored to follow in his footsteps.
I also feel privileged to speak in this bastion of American capitalism and applaud the Chamber's role as a forceful advocate for the free enterprise system. Our brand of market-based capitalism is the greatest wealth-creation machine the world has ever known, and it is through the good offices of the Chamber, as well as the many institutions represented here today, that we have confidence our market-based economy will continue to be the engine of growth and prosperity for our country.
At the same time, I have learned from my experience in the private, public, and non-profit sectors that any well-functioning system depends on a properly designed set of rules, as well as adherence to those rules. History tells us that wholly unregulated or overly regulated markets whither and die. Prudently regulated markets, on the other hand, will thrive and prosper. That is certainly true of the capitalist system, and the particular subset of it that I want to talk about today-the defined benefit pension system.
With more than $1.5 trillion in assets (and, unfortunately, even larger liabilities), the private sector defined benefit system is a major player in the U.S. economy and financial markets. At the macro level, pension funds provide a significant and patient source of the capital our businesses need to grow. Just as important, the defined benefit system provides more than $120 billion in benefits each year to nearly 12 million Americans, a vitally important income stream that makes our retirements more secure and fuels the consumer spending we need for GDP growth.
Yet for all the good they accomplish, defined benefit plans are beset at the moment with a variety of challenges. One of the most significant, in my view, is a flawed set of rules governing the system. In some cases, these rules are simply being ignored-for example, by those who have chosen to stop funding the pension promises they have made, despite federal requirements that they do so. In other cases, the rules are inadequate, failing to provide the necessary protection for participants, premium payers and taxpayers that is so vital to the system.
Before I describe the weaknesses in those rules in greater detail, I want to make something clear to the 44 million Americans whose pensions we insure and the one million Americans whose pensions we are now responsible for paying. While the PBGC is under increasing financial pressure, we stand ready to carry out our mission of paying benefits to participants in pension plans that may terminate, and we have sufficient resources to pay benefits to participants in PBGC-trusteed plans for a number of years into the future.
At the same time, the longer-term solvency of the pension insurance program is clearly at risk, and that is what I want to address briefly today.
Considerable attention has been and should be paid to the PBGC's financial position. The Corporation's single-employer insurance fund had a record deficit at the end of the last fiscal year of $11.2 billion, and we will be reporting a significantly increased deficit for this fiscal year. Obviously, developments in the airline industry are a major source of concern and have profound financial and policy implications for the federal pension insurance program.
United Airlines has said it will not make any further contributions to its pension plans and "likely" will terminate them, saddling participants and the PBGC with losses of $8.3 billion. US Airways, which recently re-entered bankruptcy, also announced that it is suspending contributions to pension plans that are already underfunded by an estimated $2.3 billion. Delta has publicly stated that it may have to enter Chapter 11, and other airlines have indicated that they would not be able to remain competitive if their principal rivals were able to shed their pension costs. We estimate the total exposure of participants and the pension insurance program to the airline industry was $31 billion as of the end of 2003.
While developments in the airline industry are cause for concern, they are only symptomatic of a broader and deeper set of problems confronting the pension insurance program, plans sponsors, and beneficiaries. I believe these issues can be distilled to two central themes-corporate responsibility and retirement security. Simply put, companies should be held accountable to make good on the pension promises they have made to their workers and retirees. The consequences of not honoring these commitments are unacceptable-the retirement security of millions of current and future retirees is put at risk, a theme I return to in a moment.
When underfunded pension plans terminate, three groups can lose: workers face the prospect of benefit reductions; other companies, including those that are healthy and have well funded plans, may face higher PBGC premiums; and ultimately taxpayers may be called upon by Congress to bail out the pension insurance fund, just as was the case more than a decade ago with the savings and loan bailout. This is the unfortunate but all too predictable result of a system that allows-and even encourages-companies to avoid paying for the promises they have made.
I would group the structural flaws in the pension insurance program into a few general categories.
The first is a Byzantine and often ineffectual set of funding rules. The rules are needlessly complex, riddled with loopholes and fail to ensure that many pension plans are adequately funded. The bottom line is that we wouldn't be here today if the funding rules worked properly.
The second problem is what economists refer to as "moral hazard." A properly designed insurance system has various mechanisms for encouraging responsible behavior and discouraging risky behavior. But a poorly designed system can be gamed. A weak company will have incentives to make generous pension promises rather than increase wages, and employees may go along because pension benefits are guaranteed. If the company recovers, it may be able to afford the increased benefits. If not, the costs of the insured portion of the increased benefits are shifted to the insurance fund.
The third category is the lack of transparency in the system. The funding and disclosure rules seem intended to obfuscate economic reality. That is certainly their effect-to shield relevant information from participants, investors and even regulators. Even the limited underfunding data the PBGC does receive cannot be made public under current law.
These structural flaws not only threaten the solvency and undermine the integrity of the pension insurance program but are part of a broader set of forces that must be addressed to ensure the viability of the defined benefit system. The trend lines paint a disturbing picture. Traditional defined benefit pension plans, based on years of service and either final salary or a specified benefit formula, at one time covered a significant portion of the workforce, providing a stable source of income to supplement Social Security. The number of private sector defined benefit plans grew through the 1960s and '70s before reaching a peak of 112,000 in the mid-1980s. At that time, some 40 percent of Americans workers were covered by defined benefit plans.
Since then, there has been steady erosion. Over the past two decades, the number of defined benefit plans has fallen by 75 percent to just over 31,000 plans today. Moreover, just 1 in 5 workers-20 percent of the workforce-now participates in a private sector defined benefit plan. Notably, no new plans of significant size have been established in recent years.
But the decline in the number of plans offered and workers covered doesn't tell the whole story of how changes in the defined benefit system have impacted retirement income. There are other significant factors that can undermine the goal of a stable income stream for aging workers.
For example, in lieu of outright termination, companies are increasingly "freezing" plans. Surveys by pension consulting firms show that many of their clients have or are considering instituting some form of plan freeze. PBGC is also conducting its own survey on plan freezes to obtain more comprehensive data on the phenomenon.
Freezes not only eliminate workers' ability to earn additional pension benefits but often serve as a precursor to plan termination, which further erodes the premium base of the pension insurance program. Workers and retirees deserve the opportunity to have a number of options for retirement security, which is why the Administration is committed to making defined benefit plans a legally and regulatorily viable option for employers.
The PBGC and others in the Administration have been hard at work identifying the challenges facing the defined benefit pension system and proposing responsible solutions for more than two years. As far back as June of 2002, my predecessor testified before Congress that PBGC was facing a big financial challenge. His warning, considered dire at the time, seems prescient today:
"I'm concerned that our surplus may decline even further ... [W]e still face over $9 billion in underfunding in the steel industry, nearly half of which is in companies that are in bankruptcy proceedings. We also face large amounts of underfunding in troubled companies in the airline and retail sectors."
In July of 2003, Assistant Labor Secretary Ann L. Combs and Treasury Undersecretary Peter R. Fisher gave testimony detailing the initial reform proposals for Congress.
As the necessary initial step toward comprehensive reform of the funding rules, the first proposal was to improve the accuracy of the pension liability measurement to reflect the time structure of each pension plan's benefit payments. The second proposal was to require better disclosure to workers, retirees, investors and creditors about the funded status of pension plans, which will improve incentives for adequate funding. And, the third proposal would provide new safeguards against underfunding by requiring financially troubled companies with highly underfunded plans to immediately fund or secure backing for additional benefits, benefit improvements, and lump sum payments.
Ultimately, we need comprehensive reform of the laws governing defined benefit pension plans in order to put the system on a sustainable path. The goals of reform are straightforward-to protect the pensions of the 44 million workers and retirees who are relying on the promises made by their employers; to ensure that companies adequately fund the promises they make; and to eliminate the incentive for companies to shift to others the cost of unfunded pension obligations, while also encouraging those companies who sponsor plans to remain in the system.
To meet these goals, we need to streamline and strengthen the ERISA funding rules. Reform must provide sounder pension plan funding. The level of underfunding in the private defined benefit system-estimated last year to be more than $350 billion-poses a substantial risk. We need to stop the hole from getting bigger. Then, we need to begin to fill the hole in a responsible and measured manner.
The current funding rules must be strengthened to ensure that accrued benefits are adequately funded. This is particularly important for those plans at the greatest risk of terminating. Various weaknesses in current law-funding holidays, so-called credit balances, unfunded benefit increases and weak liability measures-need to be fixed with a new set of rules that require sponsors falling below minimum funding levels to fund up. The rules should also be simpler and provide greater flexibility, especially for financially healthy plan sponsors. Overly prescriptive funding rules for companies that pose little or no risk of loss discourage those companies from maintaining their defined benefit plans. If we harbor any hope of keeping healthy companies in the defined benefit system we need to give them better incentives. We should allow higher tax-deductible contributions during good economic times and minimize precipitous funding increases during tough economic times.
We also need to rationalize PBGC's premium structure. The objective is to implement a premium structure that meets the PBGC's long-term revenue needs and appropriately reflects the risks that it covers. Currently, PBGC's premium income is inadequate to cover projected claims, and the premium structure provides minimal incentives for plans to remain funded.
The heavy reliance of the premium structure on flat-rate charges leads to insurance that is underpriced for bad risks and that shifts wealth from healthy companies to unhealthy companies, as evidenced by the 70 percent of claims from the steel and airline industries. PBGC premiums can also play a useful role in encouraging sound plan funding and discouraging risky behavior. The premium structure should be reformed to provide sound incentives, to reflect the risks faced by the PBGC, including both potential claim incidence and claim severity, and to appropriately fund the federal insurance program.
We must require more timely, meaningful information on pension plans' funding levels. Too often in recent years, participants in defined benefit plans have mistakenly believed that their plans were well funded, only to receive a shock when the plan is terminated and benefits are lost. United Airlines' workers should have known much earlier that they stand to lose nearly $2 billion in benefits if the plans are terminated. Investors are also put at risk when the true impact of a company's pension plan on its capital structure and future earnings is hidden from view. Simply put, workers, retirees, investors, and regulators need better and more timely information regarding the financial condition of pension plans.
Finally, the PBGC needs better tools to carry out its statutory responsibilities effectively. Recent events demonstrate that our ability to protect the interests of plan participants is limited, especially when a company is in bankruptcy. The decisions by United Airlines and US Airways to halt pension contributions-and to do so without consequence-highlights the problem. Outside of bankruptcy the PBGC can perfect a lien against plan sponsors for missed contributions. If we enjoyed the same authority inside bankruptcy we could better protect the interests of workers and retirees. Bankruptcy should be the path of last resort for companies to deal with pension issues, not the path of least resistance.
The challenges facing retirement security in America are not limited to defined benefit pension plans. The fact is, all of our nation's retirement systems-Social Security, defined benefit plans, and retirement savings accounts such as 401(k)s-are underfunded relative to the retirement promises and goals we have set for ourselves as a nation. This problem will worsen in coming years given the inexorable aging of our population.
The challenge of achieving retirement security calls for a comprehensive and coordinated solution. Not only must we strengthen Social Security and employer-sponsored pensions-both defined benefit and defined contribution plans-but we must explore new vehicles for enhancing private saving for retirement. The objectives should be to encourage and provide a stable source of income in retirement years and to enable real wealth accumulation-heeding the President's call for an "Ownership Society."
Social Security provides a basic level of retirement income. Private savings vehicles, such as IRAs, are designed to encourage capital accumulation. Employer-based programs are well suited to contribute to fulfillment of both objectives-stable income and wealth accumulation-through traditional pensions and defined contribution plans.
The Administration's proposals to strengthen the defined benefit system are just one aspect of a considered and comprehensive approach to achieving the objective of retirement security. Where previous efforts to address weaknesses in retirement security have been piecemeal and incremental, this Administration is resolved to ensure that issues are addressed holistically to keep the entire fabric of the nation's retirement system robust.
I am confident that solutions to our retirement challenges are achievable, and I look forward to working with various stakeholders to find them as expeditiously as possible-not least the businesses that offer valuable retirement benefits to their employees, often at great cost. I understand that the defined benefit pension system is voluntary, and that unless we provide employers with the proper incentives, this important retirement vehicle may disappear. That is why, in addition to the legislative changes we are considering, I want to reiterate my pledge to do whatever I can on the regulatory front to make defined benefit plans more attractive. If there are ways we can simplify, streamline and strengthen the regulatory structure for the benefit of plan sponsors and plan participants, I expect and hope you will let me know.
With that, I want to thank you for the opportunity to speak to you today, and I'd be happy to take your questions.