GAO-05-294, Private Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules


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Report to Congressional Committees: 

United States Government Accountability Office: 

GAO: 

May 2005: 

Private Pensions: 

Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses 
in Funding Rules: 

GAO-05-294: 

GAO Highlights: 

Highlights of GAO-05-294, a report to congressional committees: 

Why GAO Did This Study: 

Pension funding rules are intended to ensure that plans have sufficient 
assets to pay promised benefits to plan participants. However, recent 
terminations of large underfunded plans, along with continued 
widespread underfunding, suggest weaknesses in these rules that may 
threaten retirement incomes of these plans' participants, as well as 
the future viability of the Pension Benefit Guaranty Corporation (PBGC) 
single-employer insurance program. We have prepared this report under 
the Comptroller General's authority, and it is intended to assist the 
Congress in improving the financial stability of the defined benefit 
(DB) system and PBGC. We have addressed this report to each 
congressional committee of jurisdiction to help in their deliberations. 
This report examines: (1) the recent funding and contribution 
experience of the nation's largest private DB plans; (2) the funding 
and contribution experience of large underfunded plans, and the role of 
the additional funding charge (AFC); and (3) the implications of large 
plans' recent funding experiences for PBGC, in terms of risk to the 
agency's ability to insure benefits. 

What GAO Found: 

Each year from 1995 to 2002, while most of the largest DB pension plans 
had assets that exceeded their current liabilities, 39 percent of plans 
on average were less than 100 percent funded. By 2002, almost one- 
fourth of the 100 largest plans were less than 90 percent funded. 
Further, because of leeway in the actuarial methodology and assumptions 
sponsors may use to measure plan assets and liabilities, underfunding 
may actually have been more severe and widespread than reported. 
Additionally, 62.5 percent of sponsors of the largest plans each year 
on average made no cash contribution because the rules allow sponsors 
to satisfy minimum funding requirements through plan accounting credits 
that substitute for cash contributions. 

From 1995 to 2002, only 6 unique plans in our sample were subject to an 
additional funding charge (AFC), the primary funding mechanism to 
address underfunding, a total of 23 times. By the time a firm was 
subject to an AFC, its plan was likely significantly underfunded, and 
such plans remained poorly funded. By using other funding credits, just 
over 30 percent of the time sponsors of these plans were able to forgo 
cash contributions in the years their plans were assessed an AFC. Two 
very large and significantly underfunded plans terminated without their 
sponsors owing a cash contribution in the 3 years prior to termination, 
illustrating further weaknesses in the AFC. 

To the extent that financially weak firms sponsor underfunded plans, 
weaknesses in funding rules create a potentially large financial risk 
to PBGC and thus retirement security generally. From 1995 to 2002, on 
average each year, 9 of the largest 100 plans had a sponsor with a 
speculative grade credit rating, suggesting financial weakness and poor 
creditworthiness. Plans of speculative grade-rated sponsors had lower 
average funding levels and were more likely to incur an AFC than other 
plans. As of September 30, 2004, PBGC estimated that plans of 
financially weak companies with a "reasonably possible" chance of 
termination had plans with an estimated $96 billion in underfunding. 

Funding Levels among the Annual 100 Largest DB Plans, 1995-2002: 

[See PDF for image]

[End of figure]

What GAO Recommends: 

The Congress should consider broad pension reform that is comprehensive 
in scope and balanced in effect. However, if features of current 
regulation are retained, Congress should consider measures to 
strengthen the AFC and limit the use of funding standard account 
credits to substitute for cash contributions. 

www.gao.gov/cgi-bin/getrpt?GAO-05-294. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Barbara Bovbjerg at (202) 
512-7215 or bovbjergb@gao.gov. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

Many of the 100 Largest Plans' Liabilities Exceeded Plan Assets from 
1995 to 2002, and Few Sponsors Were Required to Make Cash 
Contributions: 

Very Few Sponsors of Underfunded Large Plans Paid an AFC from 1995 to 
2002: 

Large Plans' Sponsors' Credit Ratings Appear Related to Certain Funding 
Behavior and Represent Risk to PBGC: 

Conclusions: 

Matters for Congressional Consideration: 

Agency Comments: 

Appendix I: Scope and Methodology: 

Appendix II: Statistics for Largest 100 Defined Benefit Plans, 1995-
2002: 

Appendix III: Comments from the Department of Labor: 

Appendix IV: Comments from the Pension Benefit Guaranty Corporation: 

Appendix V: GAO Contact and Staff Acknowledgments: 

Glossary: 

Related GAO Products: 

Tables: 

Table 1: FSA Credits and Charges for Bethlehem Steel and LTV Steel 
Plans, 2000-2002: 

Table 2: Average Plan Size and Funding Levels: 

Table 3: Cash Contributions: 

Table 4: Funding Standard Account (FSA) Credits, Other than Cash 
Contributions: 

Table 5: Full Funding Limitation (FFL): 

Table 6: Additional Funding Charge (AFC): 

Figures: 

Figure 1: Accumulated Surplus/Deficit and Annual Net Gain/Loss of PBGC 
Single-Employer Program: 

Figure 2: Almost One-Fourth of the Largest Pension Plans Were Less than 
90 Percent Funded on a Current Liability Basis in 2002: 

Figure 3: Most Sponsors Made No Cash Contribution Most Years: 

Figure 4: Average Cash Contributions, as a Percentage of Minimum 
Required Annual Funding, Were Lowest during Strong Funding Years: 

Figure 5: Distribution of Average Cash Contributions, as a Percentage 
of Minimum Required Annual Funding, Illustrates that Plans Relied More 
Heavily on FSA Credits to Meet Minimum Funding Obligations from 1997 to 
2000: 

Figure 6: For Selected Years from 1996 to 2002, Most Sponsors 
Contributed the Plan's Maximum Deductible Amount, Which for a Number of 
Plans Was Zero: 

Figure 7: Most Plans Less than 90 Percent Funded Were Not Assessed an 
AFC: 

Figure 8: AFC Assessments Sometimes Exceeded Cash Contributions of 
Plans Subject to AFC, 1995-2002: 

Figure 9: Plans Sponsored by Firms with a Speculative Grade Rating 
Generally Had Lower Levels of Funding on a Current Liability Basis: 

Figure 10: Sponsors with Speculative Grade Ratings Are More Likely to 
Use the Highest Allowable Interest Rate to Estimate Current Plan 
Liabilities: 

Figure 11: Total Underfunding among All DB Plans, and among Those 
Considered by PBGC as Reasonably Possible for Termination, Has 
Increased Markedly since 2001: 

Figure 12: Over 80 Percent of Sponsors Associated with PBGC's Largest 
Termination Claims Had Speculative Grade Ratings 10 Years prior to 
Termination: 

Abbreviations: 

AFC: additional funding charge: 

DB: defined benefit: 

DRC: deficit reduction contribution: 

ERISA: Employee Retirement Income Security Act: 

FFL: full funding limitation: 

FSA: funding standard account: 

IRC: Internal Revenue Code: 

OBRA '87: Omnibus Budget Reconciliation Act of 1987: 

PBGC: Pension Benefit Guaranty Corporation: 

PRAD: Policy, Research and Analysis Department: 

S&P: Standard and Poor's: 

United States Government Accountability Office: 

Washington, DC 20548: 

May 31, 2005: 

Congressional Committees: 

The Pension Benefit Guaranty Corporation's (PBGC) single-employer 
insurance program is a federal program that insures certain benefits of 
the more than 34 million worker, retiree, and separated vested 
participants of over 29,000 private sector defined benefit (DB) pension 
plans. In recent years, because of unfavorable economic conditions and 
the collapse of large underfunded pension plans sponsored by well-known 
firms like Bethlehem Steel, U.S. Airways, and United Airlines, the 
program's financial condition has worsened significantly. From a $9.7 
billion surplus at the end of fiscal year 2000, the program reported a 
$23.3 billion deficit as of September 2004, including a $12.1 billion 
loss for fiscal year 2004.[Footnote 1] In addition, financially weak 
firms sponsored DB plans with a combined $96 billion of underfunding as 
of September 2004, up from $35 billion as of 2 years earlier.[Footnote 
2] These figures illustrate both PBGC's current financial difficulties 
and the ongoing threat underfunded DB pension plans pose to the agency. 

The Employee Retirement Income Security Act of 1974 (ERISA), as 
amended, and the Internal Revenue Code (IRC) prescribe pension funding 
rules to determine how much a firm sponsoring a DB pension plan (or 
"sponsor") must contribute to its plans each year.[Footnote 3] An 
amendment to ERISA and the tax code added the additional funding charge 
(AFC), a supplementary charge assessed to sponsors of certain 
underfunded plans.[Footnote 4] While these funding rules seek to ensure 
that plans contain sufficient assets to pay promised pension benefits 
to plan participants, recent terminations of large and severely 
underfunded pension plans have called into question their 
effectiveness. 

We have prepared this report under the Comptroller General's authority, 
and it is intended to assist the Congress in improving the financial 
stability of the defined benefit system and PBGC. As it may prove 
helpful in the deliberations of committees with jurisdiction over 
pension issues, we have addressed this report to each of these 
committees. In previous reports, we have called for comprehensive DB 
pension reform that, among other elements, would include changes to the 
current funding rules to encourage firms to better, and more 
transparently, fund their plans. We have also called for a range of 
PBGC insurance program and other related reforms.[Footnote 5] Because 
of the risks facing the single-employer program, in July 2003 we placed 
the program on our high-risk list of government operations facing 
significant vulnerabilities.[Footnote 6] Further, there are parallels 
between the financial problems of the DB pension system and those of 
Social Security, currently the focus of domestic public policy debate, 
as well as the broader long-term budgetary challenges facing the 
federal government.[Footnote 7]

To assess how well the minimum funding rules have performed and to 
better understand how key rules work to protect plans from becoming 
severely underfunded, we will address the following issues: (1) the 
recent trend in funding and contribution behavior for the nation's 
largest private DB plans, (2) the funding and contribution experience 
of large underfunded plans and the role of the AFC, and (3) the 
implications of large plans' recent funding experience for PBGC, in 
terms of risk to the agency's ability to insure benefits. 

Our analysis focused on DB pension data for the 100 largest plans as 
ranked by current liabilities reported on Schedule B of the Form 
5500[Footnote 8] each year from 1995 to 2002, as well as on financial 
information on sponsors of these large plans.[Footnote 9] For details 
on our scope and methodology, please see appendix I. Our work was done 
in accordance with generally accepted government auditing standards 
from November 2003 to May 2005. 

Results in Brief: 

From 1995 to 2002, while most of the 100 largest plans had assets that 
exceeded their current liabilities, on average 39 of these plans each 
year were less than 100 percent funded on a current liability basis; 
that is, their plans' current liabilities exceeded plan assets reported 
at their actuarial value. Overall, reported plan funding levels were 
generally stable and strong over the late 1990s, with no more than 9 of 
the 100 largest plans less than 90 percent funded in any year from 1996 
to 2000. However, by 2002 over half of the 100 largest plans were less 
than 100 percent funded, and approximately 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 on the Form 5500. Additionally, 
each year on average 62.5 percent of sponsors of the 100 largest plans 
made no annual cash contributions to their plans. One key reason for 
limited or no contributions 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. 

From 1995 to 2002, very few sponsors of the 100 largest plans were 
required to pay an additional funding charge (AFC), a funding mechanism 
designed to reduce severe plan underfunding. Most of the affected plans 
were less than 80 percent funded by the time they were assessed an AFC, 
and those that owed an AFC were likely to remain significantly 
underfunded and owe the AFC again in the future. Further, sponsors of 2 
severely underfunded plans that terminated were sometimes subject to a 
small or no AFC, and made no cash contributions in the 3 years prior to 
termination. Because funding rules allow sponsors owing an AFC to use 
credits other than cash contributions to satisfy funding requirements, 
sponsors' contributions on average were less than the AFC assessed. 
Just over 30 percent of the time a plan was assessed an AFC, the 
sponsor of that plan did not make a cash contribution in the year that 
the AFC was assessed. 

Underfunded plans sponsored by financially weak firms pose a greater 
risk to PBGC than do other plans. From 1995 to 2002, on average, 9 
percent of the largest 100 plans each year had a sponsor with a 
speculative grade credit rating, suggesting these firms' financial 
weakness and poor creditworthiness. Firms with a speculative grade 
credit rating were more likely to sponsor underfunded plans, implying 
that these plans presented a significant risk to PBGC and other premium 
payers. As a group, these plans had lower average funding levels and 
were more likely to incur an AFC. In addition, speculative grade-rated 
sponsors generally had a higher incidence of using the highest legally 
allowable interest rate to discount reported plan liabilities. The use 
of higher interest rates tends to depict plan funding in a more 
optimistic light. To the extent that the interest rates used by plans 
are overly optimistic, these plans have the potential to create 
additional financial exposure and thus risk to PBGC. Of PBGC's 41 
largest claims in which the rating of the sponsor was known, 39 have 
involved plan sponsors that were rated as speculative grade just prior 
to termination. Among these claims, over 80 percent of plan sponsors 
were rated as speculative grade 10 years prior to termination. The 
future outlook is similar: Plans sponsored by companies with 
speculative grade credit ratings and classified by PBGC as "reasonably 
possible" for termination represent an estimated $96 billion in 
potential claims. 

Because the current DB pension funding rules appear to expose PBGC and 
participants to the risk that plans will have insufficient assets to 
pay promised benefits, this report raises two matters for congressional 
consideration. To the extent that the current funding framework is 
retained, these matters regard reforms to the funding rules that might 
be considered to reduce the number and severity of underfunded plans 
and the single-employer program's financial exposure. 

Background: 

In DB plans, formulas set by the employer determine employee benefits. 
DB plan formulas vary widely, but benefits are frequently based on 
participant pay and years of service, and typically paid upon 
retirement as a lifetime annuity, or periodic payments until 
death.[Footnote 10] 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.[Footnote 11] 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 promised benefits. 

Before the enactment of ERISA, few rules governed the funding of DB 
pension plans, and participants had little assurance that they would 
receive the benefits promised. 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 contain 
enough assets to pay promised benefits. In principle, a sponsor must 
annually fund the amount required to fund the plan's "normal cost," the 
amount of earned benefits allocated during that year, plus a specified 
portion of other liabilities that may be amortized over a period of 
years. 

Compliance with the minimum funding requirements is recorded through 
the plan's funding standard account (FSA). The FSA tracks events that 
affect the financial health of a plan during that plan year: credits, 
which reflect improvements to the plan's assets, such as contributions, 
amortized experience gains,[Footnote 12] and interest; and charges, 
which reflect an increase in the plan's financial requirements, such as 
the plan's normal cost and amortized charges such as the initial 
actuarial liability, experience losses, and increases in a plan's 
benefit formula.[Footnote 13] If FSA credits exceed charges in a given 
plan year, the plan's FSA registers a net "credit balance" that may be 
carried forward to the next plan year; conversely, a prior year's 
funding deficiency also carries forward. The FSA credit balance at year-
end is equal to the FSA credit balance at the beginning of the year 
plus FSA credits less FSA charges. Compliance with the minimum funding 
standard requires that the FSA balance at the end of the year is non-
negative. An existing credit balance accrues interest and may be drawn 
upon to help satisfy minimum funding requirements for future plan 
years, and therefore may offset the need for future cash contributions. 

ERISA and the IRC prescribe rules regarding the assumptions that 
sponsors must use to measure plan liabilities and assets. For example, 
for plan years 2004 and 2005, the IRC specifies that the interest rate 
used to calculate a plan's current liability must fall within 90 to 100 
percent of the weighted average of the rate on an index of long-term 
investment-grade corporate bonds during the 4-year period ending on the 
last day before the beginning of the plan year.[Footnote 14] Similarly, 
rules dictate that sponsors report an "actuarial" value of assets that 
must be based on reasonable assumptions and must take into account the 
assets' market value.[Footnote 15] This value may differ in any given 
year, within a specified range,[Footnote 16] from the current market 
value of plan assets, which plans also report. 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.[Footnote 17]

Funding rules generally treat a plan as an ongoing entity, 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 AFC, introduced by the Omnibus 
Budget Reconciliation Act of 1987 (OBRA '87). The AFC requires sponsors 
of plans with more than 100 participants that have become underfunded 
to a prescribed level to make additional plan contributions in order to 
prevent funding levels from falling too low. With some exceptions, 
plans with an actuarial value of assets below 90 percent of current 
liabilities are affected by the AFC rules.[Footnote 18] The rules for 
determining the amount of the AFC are complex, but they generally call 
for sponsors to pay a percentage of their unfunded liability. Under 
current law, plans that owe an AFC may still apply FSA credits to meet 
their funding obligation and therefore may not be required to satisfy 
the AFC with a cash contribution. 

In addition to setting funding rules, ERISA established PBGC to 
guarantee the payment of the pension benefits of participants, subject 
to certain limits, in the event that the plan could not.[Footnote 19] 
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.[Footnote 20] PBGC may pay only a portion 
of a participant's accrued benefit because ERISA places limits on the 
PBGC benefit guarantee. For example, PBGC generally does not guarantee 
benefits above a certain amount, currently $45,614 annually per 
participant at age 65.[Footnote 21] Additionally, benefit increases 
arising from plan amendments in the 5 years immediately preceding plan 
termination are not fully guaranteed, although PBGC will pay a portion 
of these increases.[Footnote 22] Further, PBGC's benefit guarantee is 
limited to the monthly straight life annuity benefit the participant 
would receive if she were to commence the annuity at the plan's normal 
retirement age.[Footnote 23] Sponsors of PBGC-insured DB plans pay 
annual premiums to PBGC for their coverage. 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.[Footnote 
24]

Despite the presence of minimum funding rules and the AFC, plan 
underfunding has persisted. In recent years, the level of total plan 
underfunding has increased rapidly, from about $39 billion in 2000 to 
an amount estimated to exceed $450 billion as of September 30, 2004. 
While the single-employer program has over $39 billion in assets to pay 
benefits in the near term, it already faces liabilities of over $62 
billion. Thus, there is concern that the expected continued termination 
of large plans by bankrupt sponsors will push the program more quickly 
into insolvency, generating greater pressure on the Congress, and 
ultimately the taxpayers, to provide PBGC financial assistance to avoid 
reductions in guaranteed payments to retirees.[Footnote 25] Because of 
concerns about the long-term viability of the single-employer program, 
as illustrated by its growing accumulated deficit (see fig. 1), in July 
2003 we placed the program on GAO's high-risk list of agencies and 
programs that need broad-based transformations to address major 
challenges. In October 2003, 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.[Footnote 26] These suggested reforms included 
strengthening funding rules, along with possibly modifying program 
guarantees; restructuring PBGC premiums; improving the transparency of 
plan and program information; and certain other reforms. 

Figure 1: Accumulated Surplus/Deficit and Annual Net Gain/Loss of PBGC 
Single-Employer Program: 

[See PDF for image]

[End of figure]

GAO has a statutory responsibility for auditing the overall financial 
position of the executive branch of the U.S. government. In a recent 
report, we describe the serious challenges facing the nation from 
current fiscal policies that, if unchecked, will lead to large, 
escalating, and unsustainable budget deficits.[Footnote 27] This fiscal 
challenge stems in part from increasing obligations of retirement- 
related programs like Social Security, which faces long-term financial 
insolvency because of increased life expectancy. Improvements in life 
expectancy have extended the average amount of time spent by workers in 
retirement, from 11.5 years in 1950 for the average male worker to 18 
years as of 2003. 

In February 2005, the Administration proposed several measures designed 
to strengthen funding for single-employer DB pension plans.[Footnote 
28] The main elements of reform include (1) reforming the funding rules 
to ensure that sponsors keep their retirement promises; (2) improving 
disclosure to workers, investors, and regulators about pension plan 
status; and (3) reforming premiums to better reflect a plan's risk and 
restoring the PBGC to financial health. The Administration asserts that 
such changes would shore up the structural problems in the DB system 
and strengthen the system's financial health. 

Many of the 100 Largest Plans' Liabilities Exceeded Plan Assets from 
1995 to 2002, and Few Sponsors Were Required to Make Cash 
Contributions: 

From 1995 to 2002, while most of the 100 largest plans had sufficient 
assets to cover their plan liabilities, many did not. On average, each 
year 39 of these plans were less than 100 percent funded, and 10 had 
assets below 90 percent of their current liabilities. Reported funding 
levels for the group generally were stable and strong from 1996 to 
2000, but they worsened somewhat in 2001 before deteriorating 
noticeably in 2002. Furthermore, because of leeway in the actuarial 
methodology and assumptions sponsors may use to measure plan assets and 
liabilities, underfunding may actually have been more severe and 
widespread than reported at the end of the period. Because of flexible 
funding rules permitting the use of accounting credits other than cash 
contributions to satisfy minimum funding obligations, on average 62.5 
of the 100 largest plans each year received no cash contributions from 
their sponsors, including 41 percent of plans that were less than 100 
percent funded. 

Many Plans Each Year Were Underfunded, and More Became Underfunded in 
Recent Years: 

The 100 largest plans each year from 1995 to 2002 contained mostly well-
funded plans. However, on average 39 of these plans each year were less 
than 100 percent funded; that is, for these plans, current liabilities 
exceeded the reported actuarial value of assets in the plan. An average 
of 10 plans each year had asset levels below 90 percent of their 
current liability, and 3 plans were less than 80 percent funded (see 
fig. 2).[Footnote 29]

Figure 2: Almost One-Fourth of the Largest Pension Plans Were Less than 
90 Percent Funded on a Current Liability Basis in 2002: 

[See PDF for image]

[End of figure]

As a group, funding levels among the 100 largest plans were reasonably
stable and strong from 1996 to 2000. Except for 1999, in no year did 
more than 39 plans have liabilities exceeding assets, and no more than 
9 plans each year were below 90 percent funded. In 2001 there were 
signs of increased underfunding, and by 2002, more than half of the 
largest plans were less than 100 percent funded, with 23 plans less 
than 90 percent funded. Two factors in the deterioration of many plans� 
finances were the decline in stock prices and in interest rates. From 
2000 to 2002, the Standard & Poor�s (S&P) 500 stock index declined 
sharply each year. Given that DB plans on average held approximately 
half of their assets in stocks from 1995 to 2000,[Footnote 30] the 
decline in stock prices meant a sharp decline in the value of many 
plans' pension assets. In addition, over the sample period, 30-year 
Treasury bond rates, which served as the benchmark for the rate used by 
plans to calculate pension liabilities, generally fell steadily, 
raising liabilities.[Footnote 31] The combination of lower asset values 
and higher pension liabilities had a serious adverse effect on overall 
defined benefit funding levels. 

Rules May Allow Reported Funding Levels to Overstate Current Funding 
Levels: 

Accurate measurement of a plan's liabilities and assets is central to 
the sponsor's ability to maintain assets sufficient to pay promised 
benefits, as well as to the transparency of a plan's financial health. 
Because many plans chose 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 for a number of reasons. 
These include the use of above-market rates that differ from market 
values and the use of actuarial asset values that may differ from 
current asset values. Two large plans that terminated in 2002 
illustrate the potential discrepancies between reported and actual 
funding. 

Use of an Above-Market Interest Rate to Calculate Liabilities: 

Reported current liabilities are calculated using a weighted average of 
rates from the 4-year period before the plan year. This weighting 
offers sponsors the advantage of being able to smooth fluctuations in 
liabilities that sharp swings in interest rates would cause, thereby 
reducing volatility in minimum funding requirements and making funding 
more predictable. However, the weighting reduces the accuracy of 
liability measurement because the rate anchoring reported liabilities 
is likely to differ from current market values. If the rates used to 
calculate current liabilities are falling, this would have the effect 
of decreasing the rise in reported liabilities associated with lower 
rates, making plans appear better funded than they actually were. In a 
rising interest rate environment, the opposite would be true. However, 
because rules allowed sponsors to measure liabilities using a rate 
above the 4-year weighted average, sponsors could reduce plan current 
liabilities compared with what their value would be if calculated at 
current rates.[Footnote 32] The 4-year weighted average of the 
reference 30-year Treasury bond rate exceeded the current market rate 
in 76 percent of the months between 1995 and 2002, and the highest 
allowable rate for calculating current liabilities exceeded the current 
rate in 98 percent of those months. Sponsors of the plans in our sample 
chose the highest allowable interest rate to value their current 
liabilities 62 percent of the time from 1995 to 2002. 

Use of Actuarial versus Current Asset Values: 

Similarly, for assets, the actuarial value of assets used for funding 
may differ from current market values. The actuarial value of assets 
cannot be consistently above or below market, but in a given year may 
be anywhere from 80 to 120 percent of market asset level. In our 
sample, 86 percent of plans reported a different value for actuarial 
and market assets. On average, using the market value instead of 
actuarial value of assets would have raised reported funding levels by 
6.5 percent each year. However, while the market value exceeded 
actuarial value of assets during the late 1990s, when plan funding was 
generally strong, in the weaker funding year of 2002 market assets 
dipped below actuarial assets. In 2001 and 2002, calculating plan 
funding levels using market assets would have greatly increased the 
number of plans below 90 percent funded each year. A similar 
calculation for 2002 would have drastically increased the number of 
large plans below 80 percent funded, from 6 to 24. Thus, we see some 
evidence that using actuarial asset values lowered the volatility of 
reported funding levels relative to those using market asset values. 
However, the actuarial value of assets also may have disguised plans' 
funded status as their financial condition worsened. 

Two Terminated Plans Showed Large Differences between Reported and 
Actual Funding: 

Some prominent recent plan terminations reveal some extreme 
discrepancies between reported plan funding levels and market funding 
levels. 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. The PBGC single-employer program suffered a $3.7 
billion loss as a result of that termination, its largest ever at the 
time. Similarly, LTV Steel Company reported that its pension plan for 
hourly employees was over 80 percent funded on its Form 5500 filing for 
plan year 2001. When this plan terminated in March, 2002, it had assets 
equal to 52 percent of benefits, a shortfall of $1.6 billion.[Footnote 
33]

Most Sponsors Most Years Made No Cash Contributions to Plans 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. Annual cash contributions for the 100 largest plans averaged 
approximately $97 million on plans averaging $5.3 billion in current 
liabilities.[Footnote 34] 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 (see fig. 3). 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 3: Most Sponsors Made No Cash Contribution Most Years: 

[See PDF for image]

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. 

[End of figure]

The funding rules allow sponsors to meet their plans' funding 
obligations through means other than cash contributions. If a plan has 
sufficient FSA credits from other sources, such as an existing credit 
balance or large interest or amortization credits, to at least match 
its FSA charges, then the plan does not have to make a cash 
contribution in that year. Because meeting minimum funding requirements 
depends on reconciling total annual credits and charges, and not 
specifically on cash contributions, these other credits can substitute 
for cash contributions. 

From 1995 to 2002, it appears that many of the largest plan sponsors 
substituted a significant amount of FSA credits for cash contributions. 
The average plan's credit balance carried over from a prior plan year 
totaled about $572 million (2002 dollars) each year, and 88 percent of 
plans on average carried forward a prior credit balance into the next 
plan year from 1995 to 2002. Not only could these accumulated credit 
balances help a plan to meet minimum funding obligations in future 
years, but they also accrue interest that further augments a plan's FSA 
credits. In contrast to large prior-year credit balances, annual cash 
contributions averaged only $97 million, in 2002 dollars. On average 
each year, cash contributions represented 90 percent of the minimum 
required annual funding (from cash and credits).[Footnote 35] However, 
this average figure was elevated by high levels of contributions by 
some plans in 1995, 1996 and 2002. From 1997 to 2000, when funding 
levels were generally strong, cash contributions averaged only 42 
percent of minimum required annual contributions (see fig. 4). During 
these years, a majority of plans in our sample received no cash 
contribution (see fig. 5). Cash contributions represented a smaller 
percentage of annual minimum required funding during years when plans 
were generally well funded, indicating that in these years more plans 
relied more heavily on credits to meet minimum funding obligations. 

Figure 4: Average Cash Contributions, as a Percentage of Minimum 
Required Annual Funding, Were Lowest during Strong Funding Years: 

[See PDF for image]

Note: This figure reports the average percentage across plans for each 
year. Minimum required annual funding equals total FSA charges, less 
amortization credits and interest on these credits. Sponsors can use 
other FSA credits, if applicable, to satisfy minimum funding 
requirements in lieu of cash. Plans with missing components of the 
minimum required annual funding calculation or with credits that exceed 
charges (1 plan per year on average) are excluded from the figure. 

[End of figure]

Figure 5: Distribution of Average Cash Contributions, as a Percentage 
of Minimum Required Annual Funding, Illustrates that Plans Relied More 
Heavily on FSA Credits to Meet Minimum Funding Obligations from 1997 to 
2000: 

[See PDF for image]

Note: Minimum required annual funding equals total FSA charges, less 
amortization credits and interest on these credits. Sponsors can use 
other FSA credits, if applicable, to satisfy minimum funding 
requirements in lieu of cash. Plans with missing components of the 
minimum required annual funding calculation or with credits that exceed 
charges (1 plan per year on average) are excluded from the figure. 

[End of figure]

In addition to large credit balances brought forward from prior years, 
sponsors added funding credits from other sources. For example, plans 
reported approximately $42 million (2002 dollars) each year in net 
interest credits. These credits accrue to a plan's FSA like interest on 
a bank account, accruing to an existing credit balance at the beginning 
of the plan year and to other credits, such as contributions, added 
during the plan year. Rules also allow plans to accrue credits from the 
excess of a plan's calculated minimum funding obligation above the 
plan's full funding limitation; these credits averaged $47 million 
(2002 dollars) from 1995 to 2002.[Footnote 36] Other plan events result 
in plan charges, which reflect events that increase the plan's 
obligations. For example, plans reported annual amortization losses, 
which could result from actual investment rates of return on plan 
assets below assumed rates of return (including outright losses) or 
increases in the generosity of plan benefits; these net amortization 
charges averaged almost $28 million (2002 dollars) in our sample. Total 
funding credits, offset by charges, may help satisfy a plan's minimum 
funding obligation, substituting for cash contributions, and may 
explain why a significant number of sponsors made zero cash 
contributions to their plans in many years. 

FSA Accounting Rules Can Make Required Contributions Less Volatile but 
May Obscure Funded Status and Reduce Contributions: 

The FSA credit accounting system provides some advantages to DB plan 
sponsors. Amortization rules require the sponsor to smooth certain 
events that affect plan finances over several years, and accumulated 
credit balances act as a buffer against swings in future funding 
requirements.[Footnote 37] These features often allow sponsors to 
better regulate their annual level of contributions. In contrast, 
contributions and funding levels might fluctuate greatly from year to 
year if funding were based strictly on yearly differences between the 
market value of plan assets and current liabilities. Thus, a 
contribution system with an FSA accounting feature may make funding 
requirements less volatile and contributions more predictable than one 
in which funding was based entirely on current assets and liabilities. 
Similarly, current-law measurement and funding rules provide a plan 
with some ability to dampen volatility in required funding caused by 
economic events that may sharply change a plan's liabilities or assets. 
Pension experts told us that this predictability and flexibility make 
DB sponsorship more attractive to employers.[Footnote 38]

However, the FSA accounting system, by smoothing annual contributions 
and liabilities, may distort a plan's funding level. For example, 
suppose a sponsor accrues a $1 million credit balance from making a 
contribution above the required minimum in a year. Suppose then that 
this $1 million purchases assets that lose all of their value by the 
following year. 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. 
Because of amortization rules, the sponsor would have to report only a 
portion of that lost $1 million in asset value as a plan charge the 
following year.[Footnote 39] Similarly, sponsors are required to 
amortize the financial effect of a change in a plan's benefit formula, 
which might result in increased benefits and therefore a higher funding 
obligation, over a 30-year period. Thus, even though higher benefits 
would immediately raise a plan's obligation to fund, the sponsor could 
spread this effect in the plan's FSA over 30 years. This disconnection 
between the reported and current market condition of plan finances 
raises the risk that plans will not react quickly enough to 
deteriorating plan conditions. Further, it reduces the transparency of 
plan financial information to stakeholders, such as participants, and 
investors. 

The experience of two large plans that terminated in a severely 
underfunded state help illustrate the potential disconnection between 
FSA accounting and the plan's true funded status. As stated earlier, 
the Bethlehem Steel Corporation and LTV Steel Company both had plans 
terminate in 2002, each with assets approximately equal to 50 percent 
of the value of benefits. 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 in 2002, the year of 
termination (see table 1). 

Table 1: FSA Credits and Charges for Bethlehem Steel and LTV Steel 
Plans, 2000-2002: 

Figures in millions of dollars: 

Additional funding charge; 
Bethlehem Steel: 2000: $0; 
Bethlehem Steel: 2001: $0; 
Bethlehem Steel: 2002: $181.2; 
LTV Steel: 2000: $2.2; 
LTV Steel: 2001: $73.3; 
LTV Steel: 2002: $79.4. 

Total FSA charges; 
Bethlehem Steel: 2000: $277.0; 
Bethlehem Steel: 2001: $281.0; 
Bethlehem Steel: 2002: $457.9; 
LTV Steel: 2000: $351.8; 
LTV Steel: 2001: $342.9; 
LTV Steel: 2002: $179.4. 

Prior year credit balance; 
Bethlehem Steel: 2000: $980.4; 
Bethlehem Steel: 2001: $710.8; 
Bethlehem Steel: 2002: $508.3; 
LTV Steel: 2000: $1294.3; 
LTV Steel: 2001: $1257.3; 
LTV Steel: 2002: $1169.2. 

Cash contribution; 
Bethlehem Steel: 2000: $0; 
Bethlehem Steel: 2001: $0; 
Bethlehem Steel: 2002: $0; 
LTV Steel: 2000: $0; 
LTV Steel: 2001: $0; 
LTV Steel: 2002: $0. 

Total FSA credits; 
Bethlehem Steel: 2000: $987.9; 
Bethlehem Steel: 2001: $789.3; 
Bethlehem Steel: 2002: $579.6; 
LTV Steel: 2000: $1609.1; 
LTV Steel: 2001: $1512.1; 
LTV Steel: 2002: $1218.5. 

End-of-year credit balance; 
Bethlehem Steel: 2000: $710.8; 
Bethlehem Steel: 2001: $508.3; 
Bethlehem Steel: 2002: $121.7; 
LTV Steel: 2000: $1257.3; 
LTV Steel: 2001: $1169.2; 
LTV Steel: 2002: $1039.1. 

Funded percentage (actuarial assets/current liabilities); 
Bethlehem Steel: 2000: 85.8%; 
Bethlehem Steel: 2001: 83.9%; 
Bethlehem Steel: 2002: 85.2%; 
LTV Steel: 2000: 88.1%; 
LTV Steel: 2001: 81.6%; 
LTV Steel: 2002: 58.4%. 

Funded percentage at termination (plan assets/future benefits); 
Bethlehem Steel: 2002: 48.8%; 
LTV Steel: 2002: 51.9%. 

Source: GAO Analysis of PBGC Form 5500 research data. 

Note: For funded percentage at termination represents market-valued 
assets as a percentage of PBGC-guaranteed benefits, plus any additional 
benefits funded by the plan's assets after allocation under section 
4044 of ERISA. These benefits are valued at the PBGC interest rate, 
which is different than that used to value current liability on Form 
5500. For more discussion of the differences between termination and 
current liabilities, see GAO-04-90, appendix IV. 

[End of table]

Full Funding Limitation Rule May Have Allowed Some Plan Sponsors to 
Forgo Plan Contributions: 

Another possible explanation for the many instances in which sponsors 
made no annual cash contribution regards the full funding limitation 
(FFL). The FFL is a cap on minimum required contributions to plans that 
reach a certain funding level in a given plan year.[Footnote 40] 
However, the FFL does not necessarily represent the contribution that 
would raise plan assets to the level of current liability. Between 1995 
and 2002, rules permitted some plans with assets as low as 90 percent 
of current liability to reach the FFL, meaning that a plan could be 
considered fully funded without assets sufficient to cover all accrued 
benefits. The FFL is also distinct from the plan's annual maximum tax- 
deductible contribution.[Footnote 41] Because sponsors may be subject 
to an excise tax on contributions above the maximum, the annual maximum 
contribution can act as a real constraint on cash contributions. In 
contrast, the FFL represents a "maximum minimum" contribution for a 
sponsor in a given year--a ceiling on the sponsor's minimum funding 
obligation for the plan. 

Flexibility in the FFL rule has allowed many plan sponsors to take 
steps to minimize their contributions. In our sample, from 1995 to 2002 
approximately two-thirds of the sponsors in each year made an annual 
plan contribution at least as large as the plan's FFL. However, in 65 
percent of these instances, the sponsor had chosen the highest 
allowable rate to calculate current liability; using a lower rate to 
calculate current liability may have resulted in a higher FFL, and 
therefore may have required a higher contribution. Further, the FFL was 
equal to zero for 60 percent of plans each year, on average. This means 
that these plans were permitted to forgo cash contributions as a result 
of the FFL rule. This reflects the fact that if a plan's FFL equaled 
zero, that plan had assets at least equal to 90 percent of current 
liabilities that year and would not be required to make an additional 
contribution. 

The interaction between the FFL rule and the annual maximum tax- 
deductible contribution also has implications for the amount that plan 
sponsors can contribute. In some years, the maximum deductible 
contribution rules truly constrained some sponsors from making any cash 
contribution. In 1998, 50 of 60 plans that contributed to the maximum 
deductible amount had a maximum deductible contribution of zero (see 
fig. 6). This meant that any cash contribution into those plans that 
year would generally subject the sponsor to an excise tax.[Footnote 42] 
For 37 of these plans, this was the case even if the sponsor had chosen 
the lowest statutorily allowed interest rate for plan funding purposes, 
which would have produced the highest calculated current liabilities. 
This constraint did not apply to as many plans in some other years. For 
example, in 1996, 52 plans contributed the maximum deductible amount. 
Thirty of these plans had a maximum deductible contribution of zero. 
However, 16 of these 30 could have chosen a lower rate to raise their 
maximum deductible contribution level. 

Figure 6: For Selected Years from 1996 to 2002, Most Sponsors 
Contributed the Plan's Maximum Deductible Amount, Which for a Number of 
Plans Was Zero: 

[See PDF for image]

Note: Years of analysis are not continuous, as the PBGC study on 
maximum deductible contributions was conducted for years shown. 
Information on maximum deductible contributions is missing for between 
7 and 17 plans each year. Data for these plans were either missing or 
incomplete to calculate the plan contributions with respect to the 
maximum deductible contribution. 

[End of figure]

Very Few Sponsors of Underfunded Large Plans Paid an AFC from 1995 to 
2002: 

From 1995 to 2002, an average of only 2.9 of the 100 largest DB plans 
each year were assessed an additional funding charge, the funding 
mechanism designed to prevent severe plan underfunding, 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 placed 
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. 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. Further, during this period, 2 of these 6 plans that 
owed an AFC were terminated, each with assets far below promised 
benefits and each without having had to make a cash contribution in the 
3 years prior to termination. As with plans in general, funding rules 
allowed sponsors owing an AFC to use FSA credits to help meet their 
funding obligations, in some years allowing sponsors to forgo cash 
contributions altogether. 

Few Plans Were Assessed an AFC, and These Plans Were Likely to Be Very 
Underfunded: 

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. More 
specifically, a plan that is between 80 and 90 percent funded is 
subject to an AFC unless the plan was at least 90 percent funded in at 
least 2 consecutive of the 3 previous plan years.[Footnote 43] A plan 
with assets below 80 percent of liabilities, calculated using the 
highest allowable rate, is assessed an AFC regardless of its funding 
history. 

Despite the statutory threshold of a 90 percent funding level for some 
plans to owe an AFC, in practice a plan needed to be much more poorly 
funded to become subject to an AFC. While about 10 plans in our sample 
each year had funding below 90 percent on a current liability basis, on 
average fewer than 3 plans each year owed an AFC (see fig. 7). From 
1995 to 2002, only 6 of the 187 unique plans that composed the 100 
largest plans each year were ever assessed an AFC,[Footnote 44] and 
these plans owed an AFC a total of 23 times in years in which they were 
among the 100 biggest plans. By the time a sponsor owed an AFC, its 
plan had an average funding level of 75 percent, suggesting that by the 
time the AFC was triggered, the plan's financial condition was weak. 
Further, while we observed 60 instances between 1995 and 2002 in which 
a plan had funding levels between 80 and 90 percent, only 5 times was a 
plan in this funding range subject to an AFC. This would indicate that, 
in practice, 80 percent represented the realistic funding threshold for 
owing or avoiding the AFC. 

Figure 7: Most Plans Less than 90 Percent Funded Were Not Assessed an 
AFC: 

[See PDF for image]

[End of figure]

AFC rules specify a current liability calculation method that may 
overstate actual plan funding, relative to using market measures, 
thereby reducing the number of plans that might be assessed an AFC. To 
determine if a sponsor owes an AFC, rules dictate that the sponsor 
calculate current liability using the highest allowable interest rate, 
which results in a plan's lowest possible measure of current liability. 
Because the highest allowable rate exceeded current market rates in 98 
percent of the months from 1995 to 2002, this likely lowered current 
liability measures for AFC purposes, which would cause fewer plans to 
be assessed an AFC. In our sample, 5 plans that reported funding levels 
below 80 percent on a current liability basis did not owe an AFC, 
perhaps because current liability does not require the use of the 
highest allowable interest rate. 

Sponsors that owed an AFC had mixed success at improving their plans' 
financial conditions in subsequent years, and most of these plans 
remained significantly underfunded. Among the 6 plans that owed the AFC 
at least once, funding levels rose slightly from an average 75 percent 
when the plan was first assessed an AFC to an average 76 percent, 
looking collectively at all subsequent years. All of these plans were 
assessed an AFC more than once, and 2 of the 6 plans terminated during 
the period, each with a severe shortfall of assets relative to promised 
benefits, creating large losses for PBGC's single-employer insurance 
program. Further, the AFC was an imperfect mechanism for improving 
funding of these plans prior to termination. Bethlehem Steel, which 
terminated its plan in 2002 with a funding level under 50 percent, was 
subject to an AFC that year, but not from 1997 to 2001. LTV Steel, 
which terminated its pension plan for hourly employees in 2002 with 
assets of $1.6 billion below the value of benefits, did have 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 contributed no 
cash to its plan during those years, instead using credits to satisfy 
its funding obligations (see table 1). 

Funding Rules Allow Underfunded Plans, Including Those Owing AFC, to 
Forgo Cash Contributions: 

While the formula to determine the amount is complex, the AFC equals 
approximately 18 to 30 percent of the plan's unfunded liability, with 
more underfunded plans owing a higher percentage than less underfunded 
plans.[Footnote 45] However, the funding rules allow sponsors to use 
other FSA credits, in addition to cash contributions, to satisfy 
minimum funding obligations, including the AFC. Among plans in our 
sample assessed an AFC, the average annual AFC owed was $234 million, 
but annual contributions among this group averaged $186 million, with 
both figures in 2002 dollars (see fig. 8). In addition, 61 percent of 
the time a plan was subject to an AFC, the sponsor used an existing 
credit balance to help satisfy its funding obligation. When it did so, 
the sponsor drew $283 million from the credit balance--well above what 
sponsors owing an AFC contributed in cash, on average. 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. 

Figure 8: AFC Assessments Sometimes Exceeded Cash Contributions of 
Plans Subject to AFC, 1995-2002: 

[See PDF for image]

[End of figure]

Again, terminated plans provide a stark illustration of weaknesses in 
the rules' ability to ensure sufficient funding. 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. Similarly, LTV Steel made no contributions to its 
plan from 2000 to 2002, despite being assessed an AFC in each of those 
years. Both plans were able to apply existing credits instead of cash 
to satisfy minimum funding requirements. 

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 plans 
that are sponsored by financially weak firms, illustrate the limited 
effectiveness of certain current funding rules and represent a 
potentially large implicit financial risk to PBGC. From 1995 to 2002, 
on average, 9 percent of the largest 100 plans had a sponsor with a 
speculative grade credit rating, suggesting financial weakness and poor 
creditworthiness. As a group, speculative grade-rated sponsors had 
lower average funding levels, and were more likely to incur an AFC than 
other sponsors. In addition, speculative grade-rated sponsors generally 
had a higher incidence of using the highest legally allowable interest 
rate to discount reported plan liabilities. Using a higher interest 
rate lowers a plan's calculated current liabilities and may lower the 
plan's minimum funding requirement; to the extent that this reduces 
contributions, using the highest allowable interest rate may raise the 
chances of underfunding and raise the financial exposure to PBGC. Of 
PBGC's 41 largest claims since 1975 in which the rating of the sponsor 
was known, 39 have involved plan sponsors that were rated as 
speculative grade just prior to termination. Among these claims, over 
80 percent of plan sponsors were rated as speculative grade 10 years 
prior to termination. The future outlook is similar: plans sponsored by 
companies with speculative grade credit ratings and classified by PBGC 
as "reasonably possible" of termination represent an estimated $96 
billion in potential claims. 

Speculative Grade Sponsors More Likely to Have Lower Funding Levels: 

The financial health of a plan sponsor may be key to plan funding 
decisions because sponsors must make funding and contribution decisions 
in the context of overall business operations. During our 1995 to 2002 
sample period, we observed between 7 and 13 plans each year with 
sponsors that had a speculative grade credit rating.[Footnote 
46],[Footnote 47]

From 1995 to 2002, we observed that plans with speculative grade-rated 
sponsors had lower levels of average funding compared with the average 
for the 100 largest plans. For instance, the average funding of plans 
of sponsors that were rated as speculative grade was 12 percentage 
points lower on average than the funding level for all plans from 1995 
to 2002 (see fig. 9). Applying an alternative measure of plan funding 
that used the reported market value measure of plan assets, we obtained 
broadly similar results.[Footnote 48] Plans of speculative grade-rated 
sponsors were also more likely to be underfunded. From 1995 to 2002, 
each year, on average, 18 percent of speculative grade-rated plans had 
assets that were below 90 percent of current liability. Plans of 
nonspeculative grade-rated sponsors had just over half this incidence, 
or an average of 10 percent of plans funded below 90 percent of current 
liability. 

Figure 9: Plans Sponsored by Firms with a Speculative Grade Rating 
Generally Had Lower Levels of Funding on a Current Liability Basis: 

[See PDF for image]

[End of figure]

Large plans sponsored by firms with a speculative grade rating were 
also more likely to incur an AFC. While speculative grade-rated 
sponsors accounted for only 9 percent of all sponsors from 1995 to 
2002, they accounted for just over one-third (8 of 23) of all instances 
in which a sponsor was required to pay an AFC.[Footnote 49] No high 
investment grade sponsors (those rated AAA or AA) were required to pay 
an AFC for this period. While the AFC is intended to be a backstop for 
underfunded plans, for our sample, it affected only those plans that 
were rated A or lower. The AFC may, to some extent, protect PBGC from 
additional losses so plans cannot become even more underfunded, 
especially if the plan is at risk for financial distress. However, to 
the extent that speculative grade-rated sponsors are considered to pose 
a significant risk for near-term bankruptcy, the AFC may not be an 
effective mechanism for improving a plan's funding level. Plan sponsors 
that are in financial distress are, by definition, having difficulty 
paying off debts and may be ill equipped to increase cash contributions 
to their plan. That is, the AFC itself may be a symptom of plan 
distress rather than a solution to improve a plan's funding level. AAA 
or AA rated sponsors, on the other hand, were not assessed an AFC from 
1995 to 2002, as they likely had the financial flexibility to increase 
contributions to avoid consistently falling below funding levels that 
would have triggered the AFC. 

Large plans with sponsors rated as speculative grade were generally 
more likely to report current liabilities calculated by using the 
highest allowable interest rate under the minimum funding rules. While 
a majority of sponsors from all credit rating categories used the 
highest allowable interest rate over the entire 1995 to 2002 period, 
speculative grade-rated sponsors used the highest rate at an incidence 
23 percentage points above the incidence for all other plans in the 
sample (see fig. 10). The use of higher interest rates likely lowers a 
plan's reported current liability and minimum funding requirement. To 
the extent that this depresses cash contributions, such plans may have 
a higher chance of underfunding, thus creating additional financial 
risk to PBGC. 

Figure 10: Sponsors with Speculative Grade Ratings Are More Likely to 
Use the Highest Allowable Interest Rate to Estimate Current Plan 
Liabilities: 

[See PDF for image]

[End of figure]

Speculative Grade-Rated Sponsors Represent Greater Risks to PBGC: 

Financial strength of plan sponsors' business operations has been a key 
determinant of risk to PBGC. Financially weak sponsors are, by the 
nature of the insurance offered by PBGC, likely to cause the most 
financial burden to PBGC and other premium payers. For instance, PBGC 
typically trustees a plan when a covered sponsor is unable to 
financially support the plan, such as in the event of bankruptcy or 
insolvency.[Footnote 50] Current funding rules, coupled with the 
presence of PBGC insurance, may create certain incentives for 
financially distressed plan sponsors to avoid or postpone contributions 
and increase benefits. Many of the minimum funding rules are designed 
so that sponsors of ongoing plans may smooth contributions over a 
number of years. Sponsors that are in financial distress, however, may 
have a more limited time horizon and place other financial priorities 
above "funding up" their pension plans. To the extent that moral hazard 
from the presence of PBGC insurance causes financially troubled 
sponsors to alter their funding behavior, PBGC's potential exposure 
increases.[Footnote 51]

Underfunded plans sponsored by financially weak firms pose the greatest 
immediate threat to PBGC's single-employer program. PBGC's best 
estimate of the total underfunding of plans sponsored by companies with 
credit ratings below investment grade and classified by PBGC as 
reasonably possible to terminate was an estimated $96 billion as of 
September 30, 2004 (see fig. 11).[Footnote 52]

Figure 11: Total Underfunding among All DB Plans, and among Those 
Considered by PBGC as Reasonably Possible for Termination, Has 
Increased Markedly since 2001: 

[See PDF for image]

[End of figure]

PBGC's claims experience shows that financially weak plans have been a 
source of substantial claims. Of the 41 largest claims in PBGC history 
in which a rating was known, 39 of the plan sponsors involved were 
credit rated as speculative grade 3 years prior to termination (see 
fig. 12). These claims account for 67 percent of the value of total 
gross claims on the single-employer program from 1975 to 2004.[Footnote 
53] Most of the plan sponsors involved in these claims were given 
speculative grade ratings for many more years prior to their eventual 
termination. Even 10 years prior to plan termination, 33 of the 41 plan 
sponsors involved in the largest gross claims, in which the rating of 
the sponsor was known, were rated as speculative grade.[Footnote 54]

Figure 12: Over 80 Percent of Sponsors Associated with PBGC's Largest 
Termination Claims Had Speculative Grade Ratings 10 Years prior to 
Termination: 

[See PDF for image]

Note: Based on 41 of PBGC's largest gross claims in which the rating of 
the sponsor was known, representing over 67 percent of total gross 
claims from 1975 to 2004. These 41 claims may include sponsors with 
more than one plan and are not limited to those plans in our sample. 
Ratings based on S&P rating. 

[End of figure]

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 past work has shown that the roots 
of these current pension problems are broad and structural in nature, 
and that the private DB pension system requires meaningful and 
comprehensive reform. The Administration has already presented a 
proposal for reform and others may soon emerge from the Congress. While 
the complexity of the challenges suggests a considerable debate ahead, 
the emerging consensus that action needs to be taken may be cause for 
optimism. 

Our analysis here examines the effectiveness of certain funding rules 
and suggests that these rules have contributed to the general 
underfunding of pensions and, indirectly, to PBGC's recent financial 
difficulties. The persistence of a large number of underfunded plans, 
even during the strong economic period of the late 1990s, implies that 
current funding rules are not stringent enough to ensure that sponsors 
can fund their pensions adequately. Perhaps even more troubling is that 
current rules for measuring and reporting plan assets and liabilities 
may not reflect true current values and may understate the funding 
problem. Further, the very small number of sponsors of underfunded 
plans that pay the AFC indicates that the rule needs to be strengthened 
if it is to serve as the primary mechanism for shoring up assets in 
underfunded plans. 

The current rules have the reasonable and important goals of long-term 
funding adequacy and short-term funding flexibility so as to reduce 
annual contribution volatility. However, our work shows that although 
the current system permits flexibility, it also permits reported plan 
funding to be inadequate, misleading, and opaque, and even so, funding 
and contributions for some plans can still swing wildly from year to 
year. This would appear not to serve the interest of any DB pension 
stakeholders effectively. The challenge is determining how to achieve a 
balance of interests: how to temper the need for funding flexibility 
with accurate measurement, adequate funding, and appropriate 
transparency. Our work shows that although the current system permits 
flexibility, it also permits reported plan funding to be inadequate, 
misleading, and opaque, and even so, funding and contributions for some 
plans can still swing wildly from year to year. This would appear not 
to serve the interest of any DB pension stakeholders effectively. 

Despite flaws in the funding rules, our work here shows that most of 
the largest plans appear to be adequately funded. Rules should 
acknowledge that funding will vary with cyclical economic conditions, 
and even sponsors who make regular contributions may find their plans 
underfunded on occasion. Periodic and mild underfunding is not usually 
a major concern, but it becomes a threat to workers' benefits and to 
PBGC when the sponsor becomes financially weak and the risk of 
bankruptcy and plan termination becomes likely. This suggests that 
perhaps the stringency of certain funding rules can be adjusted 
depending on the financial strength of the sponsor, with stronger 
sponsors being allowed greater latitude in funding and contributions 
than weaker sponsors that might present a near-term bankruptcy 
risk.[Footnote 55] However, focusing more stringent funding obligations 
on weak plans and sponsors is difficult in that strong firms and 
industries can quickly become risky ones, and once sponsors and plans 
become too weak, it may be difficult for them to make larger 
contributions and still recover. 

It should be noted also that while change in the funding rules is an 
essential piece of the reform puzzle, it is certainly not the only 
piece. Indeed, pension reform is a challenge precisely 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 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 
payments;

* 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. 

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. 

This reform effort should also be understood in the context of the 
problems facing other components of retirement security and the federal 
budget generally. For example, Social Security, Medicare, and Medicaid 
serve the larger population of retired and disabled workers, many of 
whom are also affected by DB reform. The demographic dynamics of 
increased longevity in life and retirement affecting the DB system also 
affect these other programs, intensifying existing fiscal pressures on 
the federal budget. Thus, DB pension reform, with these other issues, 
has important implications both for the distribution of retirement 
income for current and future generations and for our overall success 
in addressing these broader budgetary challenges.[Footnote 56]

Even with meaningful, carefully crafted reform, it is possible that 
some DB plan sponsors may choose to freeze or terminate their plans. 
Sponsor exit is a serious concern, given the important role DB plans 
play in providing retirement security. However, this is a natural 
consequence of the inherent trade-off that exists in a private pension 
system that on one hand depends on voluntary plan sponsorship and on 
the other is tax subsidized and backed by federal insurance in order to 
promote the retirement security of our nation's workers. The 
overarching goals of balanced pension reform, and particularly of 
funding rule 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. 

Matters for Congressional Consideration: 

As we have noted in previous reports,[Footnote 57] the Congress should 
consider broad pension reform that is comprehensive in scope and 
balanced in effect. Along with changes in the areas of PBGC's premium 
structure, lump-sum distributions, shutdown benefits, and other areas, 
funding rule changes should be an essential element of DB pension 
reform. Such reform may result in a system with features very different 
from the framework currently governing DB plans and PBGC. However, 
significant reforms that would place the DB system and PBGC on a 
sounder financial footing could also be enacted and could retain many 
of the features of the current regulatory system. Should the Congress 
choose to move in this latter direction, this report highlights certain 
areas where carefully crafted changes could improve plan funding. 
Specifically, the Congress should consider measures that include: 

* Strengthening the additional funding charge. One way to do this would 
be to consider raising the threshold levels of funding that trigger the 
AFC so that any sponsor with a plan less than 90 percent funded would 
have to make additional contributions. So that plans do not have an 
incentive to fund just barely above 90 percent, additional 
consideration may be given for a gradual phase-in of the AFC for plans 
that are underfunded between 90 percent and 100 percent of current 
liability. Requiring that financially weak plans that owe an AFC base 
their contributions on termination liability rather than current 
liability might add stringency to the minimum funding rules and might 
be appropriate, since weak sponsors of underfunded plans present a 
greater risk of distress termination to PBGC than other sponsors. These 
reforms could be enacted singly or jointly, but each would subject more 
plans to an AFC, and the reforms would shore up at-risk plans before 
underfunding becomes severe. 

* Limiting the use of FSA credits toward meeting minimum funding 
requirements. We have noted that some sponsors repeatedly relied on FSA 
credits, such as a prior year credit balance or net interest credits, 
to avoid making cash contributions to their plans, and that this has 
been particularly problematic for underfunded plans prior to their 
termination. While FSA credits may have the benefit of moderating 
contribution volatility in the near term, they also have the weakness 
of allowing the sponsors of severely underfunded plans to avoid cash 
contributions and may contribute to volatility later. The Congress 
should consider ways, even if it retains the FSA, to scale back the 
substitution of credits for annual cash contributions. 

While admittedly an extremely complicated matter, meaningful effective 
reform must confront the issue of accurate measurement. We found that 
that the measurement techniques of assets and liabilities that are 
permitted under current funding rules can result in distortions masking 
the true funding status of a plan and can permit sponsors to avoid 
making plan contributions. Techniques that lead to misleading 
indicators of plan health and impede information transparency are a 
disservice to all key stakeholders; to plan participants in making 
retirement decisions; to unions seeking to bargain in the interests of 
their members; to current and potential shareholders in deciding where 
to invest; and finally to the public, which is the ultimate protector 
of employee benefits. 

Agency Comments: 

We provided a draft of this report to the Department of Labor, 
Treasury, and PBGC. The Department of Labor and PBGC provided written 
comments, which appear in appendix III and appendix IV. Both the 
Department of Labor's and PBGC's comments generally agree with the 
findings and conclusions of our report. Treasury did not provide 
written comments. The Department of Labor, Treasury, and PBGC also 
provided technical comments, which we incorporated as appropriate. 

We are sending copies of this report to the Secretary of Labor, the 
Secretary of the Treasury, and the Executive Director of the PBGC, 
appropriate congressional committees, and other interested parties. We 
will also make copies available to others on request. In addition, the 
report will be available at no charge on GAO's Web site at 
http://www.gao.gov. 

If you have any questions concerning this report, please contact me at 
(202) 512-7215. Contact points for our Office of Congressional 
Relations and Public Affairs may be found on the last page of this 
report. GAO staff who made contributions are listed in appendix V. 

Signed by: 

Barbara Bovbjerg, Director: 
Education, Workforce, and Income Security Issues: 

List of Congressional Committees: 

The Honorable Charles E. Grassley: 
Chairman: 
The Honorable Max Baucus: 
Ranking Minority Member: 
Committee on Finance: 
United States Senate: 

The Honorable Michael B. Enzi: 
Chairman: 
The Honorable Edward M. Kennedy: 
Ranking Minority Member: 
Committee on Health, Education, Labor, and Pensions: 
United States Senate: 

The Honorable John A. Boehner: 
Chairman: 
The Honorable George Miller: 
Ranking Minority Member: 
Committee on Education and the Workforce: 
House of Representatives: 

[End of section]

Appendix I: Scope and Methodology: 

To describe recent pension funding trends, we analyzed data from 
Schedule B of the Form 5500. This schedule contains information on plan 
assets, liabilities, contributions, funding standard account (FSA) 
credits and charges, and additional funding charge (AFC) calculations. 

Problems with the electronic data of the Form 5500 are well 
documented.[Footnote 58] To mitigate problems associated with the data 
we used Form 5500 research data from the Pension Benefit Guaranty 
Corporation's (PBGC) Policy, Research and Analysis Department (PRAD). 
PRAD analysts routinely and systematically correct the raw 5500 data 
submitted by plans, and PRAD 5500 data are thought to be the most 
accurate electronic versions. Although we did not independently audit 
the veracity of the PRAD data, we performed routine data reliability 
checks. In instances where the data reliability checks revealed 
inconsistencies, we contacted a PRAD analyst to check and, if 
appropriate, correct the electronic data using information provided to 
PRAD in hard copy. 

For our analysis, we worked with a subset of the PBGC research data 
that included the 100 largest plans, measured by current liability, 
annually from 1995 to 2002.[Footnote 59] In 2002, the most recent, 
nearly complete year of available Form 5500 data, these 100 plans, with 
average liabilities per plan of $6.7 billion and 94,000 participants, 
represented approximately 50 percent of the total liabilities and about 
28 percent of the total participants of the approximately 30,000 
defined benefit (DB) plans that filed a Form 5500 for plan year 2002 as 
of February 2005. Thus, while our sample data set represents only a 
small portion of the total plans in the single-employer program, it 
constitutes a significant proportion of the liabilities of the DB 
system and the financial risk to PBGC while allowing for more 
manageable analysis. We did not directly test or compare our sample for 
generalizability across the entire sample of single-employer plans. 

For 1999 and 2002, the best available data do not contain all possible 
plans, and therefore it is possible that in those years complete data 
sets would yield slightly different samples for our analysis. The 1999 
data we received from PBGC came from a sample that was missing an 
estimated 2,927 of the 37,536 plans in the single-employer program, 
because of missing electronic records in that year. The 2002 data came 
from a sample still missing approximately 300 plans, because of ongoing 
processing. We believe that neither of these factors significantly 
affects our findings or our conclusions. 

To identify how the AFC is calculated and applied, we studied how the 
relevant Employee Retirement Security Act of 1974 (ERISA) and Internal 
Revenue Code (IRC) funding rules are applied, conducted a literature 
review, and interviewed researchers, government officials, pension 
actuaries, and pension sponsor groups familiar with pension funding 
rules. To analyze potential risk to PBGC, we matched sponsor credit 
ratings from the Standard and Poor's (S&P) COMPUSTAT database, provided 
to us by PBGC, to the sponsor's pension plan data.[Footnote 60] PBGC 
also provided us with detailed calculations to determine plans' full 
funding limitations for purposes of the minimum funding requirements. 
Additionally, to analyze effects of maximum deductible contributions, 
we matched the results from a previously issued PBGC study on the 
subject to our sample of plans. Our work was done in accordance with 
generally accepted government auditing standards. 

[End of section]

Appendix II: Statistics for Largest 100 Defined Benefit Plans, 1995- 
2002: 

Table 2: Average Plan Size and Funding Levels: 

(Dollar figures in millions of 2002 dollars): 

Current liability; 
Mean: $5,341.6; 
Median: $3,065.7. 

Actuarial asset levels; 
Mean: $6,019.3; 
Median: $3,397.9. 

Number of participants (actual); 
Mean: 80,431; 
Median: 59,508. 

Plan funding levels[A]; 
Mean: 112.7%; 
Median: 106.2%. 

Plans below 100% funded; 
Mean: 38.9. 

Plans below 90% funded; 
Mean: 10.4. 

Plans below 80% funded; 
Mean: 2.9. 

Funding gap, plans below 100% funded[B]; 
Mean: $425.7; 
Median: $215.7. 

Plans using highest allowable interest rate to calculate liabilities; 
Mean: 62.0%. 

Source: GAO analysis of PBGC Form 5500 research data. 

Notes: All figures represent per plan annual averages, from 1995 to 
2002, except as described differently. Annual dollar figures adjusted 
to 2002 dollars using annual consumer price index (CPI) data. 

Median figures reported are the average of individual year median 
values. 

For analysis, each year contains that year's 100 largest plans, ranked 
by current liabilities. From 1995 to 2002, 187 unique plans appear in 
at least 1 year's sample of 100 largest plans. See footnote 9 in main 
text for further explanation. 

[A] Funding levels calculated using actuarially measured assets as a 
percentage of current liabilities. 

[B] Funding gap equals current liabilities less actuarially valued 
assets, for underfunded plans. 

[End of table]

Table 3: Cash Contributions: 

(Dollar figures in millions of 2002 dollars): 

Total cash contributions; 
Mean: $97.4; 
Median: $9.4. 

Contributions/minimum funding obligation; 
Mean: 90.5%; 
Median: 19.1%. 

Sponsors forgoing cash contributions; 
Mean: 62.5%. 

Underfunded plans receiving no cash contribution; 
Mean: 41.1%. 

Source: GAO analysis of PBGC Form 5500 research data. 

Notes: All figures represent per plan annual averages, from 1995 to 
2002, except as described differently. Annual dollar figures adjusted 
to 2002 dollars using annual CPI data. 

Median figures reported are the average of individual year median 
values. 

For analysis, each year contains that year's 100 largest plans, ranked 
by current liabilities. From 1995 to 2002, 187 unique plans appear in 
at least 1 year's sample of 100 largest plans. See footnote 9 in main 
text for further explanation. 

[End of table]

Table 4: Funding Standard Account (FSA) Credits, Other than Cash 
Contributions: 

(Dollar figures in millions of 2002 dollars): 

Plans drawing down accumulated credit balance; 
Mean: 15.4%. 

Accumulated credit balance from prior years; 
Mean: $573.7; 
Median: $123.4. 

Net amortization credits; 
Mean: -$27.8; 
Median: $0. 

Full funding limitation credits; 
Mean: $46.7; 
Median: $17.0. 

Net interest credits; 
Mean: $42.2; 
Median: $4.9. 

Source: GAO analysis of PBGC Form 5500 research data. 

Notes: All figures represent per plan annual averages, from 1995 to 
2002, except as described differently. Annual dollar figures adjusted 
to 2002 dollars using annual CPI data. 

Median figures reported are the average of individual year median 
values. 

For analysis, each year contains that year's 100 largest plans, ranked 
by current liabilities. From 1995 to 2002, 187 unique plans appear in 
at least 1 year's sample of 100 largest plans. See footnote 9 in main 
text for further explanation. 

[End of table]

Table 5: Full Funding Limitation (FFL): 

(Dollar figures in millions of 2002 dollars): 

FFL amount; 
Mean: $645.6; 
Median: $24.3. 

Plans with FFL = 0; 
Mean: 60.1%. 

Sponsors contributing at least as much as FFL; 
Mean: 64.4%. 

Instances in which plan making contribution at least equal to FFL used 
highest allowable interest rate; 
Mean: 65.5%. 

Source: GAO analysis of PBGC Form 5500 research data. 

Notes: All figures represent per plan annual averages, from 1995 to 
2002, except as described differently. Annual dollar figures adjusted 
to 2002 dollars using annual CPI data. 

Median figures reported are the average of individual year median 
values. 

For analysis, each year contains that year's 100 largest plans, ranked 
by current liabilities. From 1995 to 2002, 187 unique plans appear in 
at least 1 year's sample of 100 largest plans. See footnote 9 in main 
text for further explanation. 

[End of table]

Table 6: Additional Funding Charge (AFC): 

Dollar figures in millions of 2002 dollars. 

Plans subject to AFC[A]; 
Mean: 2.9. 

AFC amount assessed; 
Mean: $234.1; 
Median: $148.2. 

Current liabilities of plans subject to AFC; 
Mean: $3,836.7; 
Median: $3,693.6. 

Funding gap of plan assessed an AFC; 
Mean: $837.1; 
Median: $953.0. 

Funded percentage of plan subject to AFC; 
Mean: 78.2%; 
Median: 74.7%. 

Plans below 90% funded subject to AFC; 
Mean: 27.7%. 

Plans 80 to 90% funded subject to AFC; 
Mean: 8.3%. 

Cash contribution, plans subject to AFC; 
Mean: $185.7; 
Median: $118.9. 

Plans subject to AFC forgoing cash contribution; 
Mean: 30.4%. 

Plans subject to AFC drawing down credit balance; 
Mean: 60.9%. 

Source: GAO analysis of PBGC Form 5500 research data. 

Notes: Figures in this table represent averages and medians of those 
plans subject to an AFC for the entire sample period, except as 
described differently. Annual dollar figures adjusted to 2002 dollars 
using annual CPI data. 

Median figures reported are the average of individual year median 
values. 

For analysis, each year contains that year's 100 largest plans, ranked 
by current liabilities. From 1995 to 2002, 187 unique plans appear in 
at least 1 year's sample of 100 largest plans. See footnote 9 in main 
text for further explanation. 

[A] This represents the average annual number of plans subject to an 
AFC. From 1995 to 2002, we observed 6 unique plans assessed an AFC, all 
of which had repeat AFC assessments. 

[End of table]

[End of section]

Appendix III: Comments from the Department of Labor: 

U.S. Department of Labor: 

Assistant Secretary for Employee Benefits Security Administration: 
Washington, D.C. 20210: 

May 6, 2005: 

Ms. Barbara Bovbjerg, Director: Education, Workforce, and Income 
Security Issues: U.S. Government Accountability Office: 441 G Street, 
N. W.: 
Washington, D.C. 20548: 

Dear Ms. Bovbjerg: 

The U.S. Government Accountability Office's (GAO) report, "Private 
Pensions: Recent Experiences of Large Defined Benefit Plans Illustrate 
Weaknesses in Funding Rules," shows the need for comprehensive pension 
reform. The study documents that a large part of today's severe funding 
and contribution problems can be traced directly to the funding rules 
themselves. The report provides a detailed analysis of how specific 
aspects of the current rules fail to ensure adequate funding. 
Underfunded plan terminations strain the pension insurance system and 
jeopardize the retirement security of the 34 million Americans 
participating in single-employer defined benefit plans. That is why the 
Administration supports comprehensive reform to improve pension 
security for workers and retirees. 

We agree with GAO's findings that underfunded plans of financially weak 
plan sponsors create a severe financial risk to the Pension Benefit 
Guaranty Corporation and to retirement security generally. We also 
agree that credit balances, funding holidays, and smoothing mechanisms 
have contributed to the widespread plan underfunding that we see today. 
Moreover, as your report demonstrates, these mechanisms mask 
underfunding, so that plan sponsors and participants discover too late 
and all too suddenly the need for drastic measures to address severe 
cumulative underfunding. 

The Administration appreciates GAO's excellent work in this important 
area. The Administration's proposal addresses the issues raised in this 
report within the framework of a comprehensive reform plan, promoting 
sound funding while providing plan sponsors with the tools to manage 
volatility. We look forward to working with the Congress to implement 
these needed reforms. 

Sincerely,

Signed by: 

Ann L. Combs: 

Assistant Secretary of Labor: 

[End of section]

Appendix IV: Comments from the Pension Benefit Guaranty Corporation: 

Pension Benefit Guaranty Corporation: 
1200 K Street, N.W., 
Washington, D.C. 20005-4026: 

Office of the Executive Director: 

May 9, 2005: 

Ms. Barbara Bovbjerg, Director:
Education, Workforce and Income Security Issues:
U.S. Government Accountability Office:
441 G Street NW: 
Washington, D.C. 20548: 

Dear Ms. Bovbjerg: 

The PBGC is pleased to comment on GAO's draft report, Recent 
Experiences of Large Defined Benefit Plans Illustrate Weaknesses in 
Funding Rules. 

The report provides compelling evidence of the need for broad pension 
reform that is comprehensive in scope. It documents the weaknesses in 
the current pension funding rules that have contributed to severe 
pension underfunding. It also highlights how underfunded plan 
terminations strain the pension insurance program and jeopardize the 
retirement security of the 34 million Americans participating in single-
employer defined benefit plans. 

As you noted in the report, the Administration recently proposed a 
comprehensive pension reform package that will strengthen the defined 
benefit pension system by (1) reforming the funding rules to ensure 
that sponsors keep their retirement promises; (2) improving disclosure 
to workers, retirees, investors, and regulators about the funding 
status of pension plans; and (3) reforming PBGC premiums to better 
reflect risk. 

We strongly agree with GAO that weaknesses in the current funding rules 
have led to severe pension underfunding that puts workers and retirees 
at risk. When an underfunded plan terminates, participants can lose as 
much as half or two-thirds of their promised benefits. We would also 
note that large losses in the pension insurance program pose risks to 
plan sponsors and taxpayers. 

There are two points the PBGC would like to emphasize. The first is 
that the underfunding problems addressed in the report have become more 
severe since the years primarily focused on in the report (1995-2002). 
At the end of fiscal 2002, PBGC's single-employer program had a deficit 
of $3.6 billion, which grew to $11.2 billion at the end of fiscal 2003 
and, as your report notes, to $23.3 billion by the end of fiscal 2004. 
In addition, the total underfunding in single- employer plans sponsored 
by financially weak firms grew from $35 billion at the end of 2002 to 
$96 billion at the end of 2004. This disturbing trend underscores the 
need for congressional action. 

The second point is the need for comprehensive reform of the defined 
benefit pension system. The GAO report focuses on the weaknesses in the 
funding rules and the need for funding reform. But it also concludes 
that funding rule changes are an essential piece of a comprehensive 
reform package, and warns against adopting individual reforms in 
isolation. This report refers to GAO's earlier report, Single-Employer 
Pension Insurance Program Faces Significant Long-Term Risks (04-90), 
that also concluded that Congress should consider comprehensive pension 
reform measures. Thus, the GAO's conclusions are consistent with the 
Administrations comprehensive reform approach that would not only 
reform the funding rules but also would also improve disclosure and 
rationalize PBGC premiums. 

We appreciate GAO's work in this important area and look forward to 
working with GAO and the Congress on measures to strengthen the defined 
benefit system and pension insurance program. 

Sincerely,

Signed by: 

Bradley D. Belt: 

[End of section]

Appendix V: GAO Contact and Staff Acknowledgments: 

Contact: 

Barbara Bovbjerg (202) 512-7215. 

Staff Acknowledgments: 

In addition to the contact above, Charles A. Jeszeck, Charles J. Ford, 
Joseph Applebaum, Mark M. Glickman, Scott Heacock, Roger J. Thomas, and 
Amy Vassalotti made important contributions to this report. 

[End of section]

Glossary: 

Actuarial value of assets--the smoothed value of DB plan assets, 
reflecting recent market levels of assets. Rules dictate that the 
reported actuarial assets must be between 80 and 120 percent of market 
asset levels and cannot be consistently above or below market values. 

Additional funding charge (AFC)--a surcharge assessed to DB plans that 
fail specific funding level requirements that increases the minimum 
required funding obligation for the plan sponsor. 

Credit balance--the excess of credits over charges in a plan's funding 
standard account, which can be carried forward to meet funding 
obligations in future years. 

Current liabilities--the measured value of a DB plan's accrued benefits 
using an interest rate and other assumptions specified in applicable 
laws and regulations. 

Defined benefit (DB) pension plan--a pension plan that promises a 
guaranteed benefit, generally based on an employee's salary and years 
of service. (A different type of pension plan, a defined contribution, 
or DC, plan, instead provides an individual account to an employee, to 
which employers, employees, or both make periodic contributions.)

Employee Retirement Income Security Act of 1974 (ERISA)--the federal 
law that sets minimum standards regarding management, operation, and 
funding of pension plans sponsored by private employers. 

Full funding limitation (FFL)--a limit on the required amount a sponsor 
must contribute to a plan each year, dependent on the plan's funding 
level. 

Funded ratio--the ratio of plan assets to plan liabilities. 

Funding standard account (FSA)--a plan's annual accounting record, 
recording events that reflect an increase in a plan's obligations 
(charges) and those that reflect an increase in the plan's ability to 
pay benefits (credits). 

Maximum deductible contribution--the maximum a sponsor can generally 
contribute to a plan without facing an excise tax on the excess 
contribution. 

Normal cost--the cost of pension benefits allocated to a specific plan 
year. 

Termination liabilities--the measured value of a DB plan's accrued 
benefits, using assumptions appropriate for a terminating plan. 

[End of section]

Related GAO Products: 

Pension Benefit Guaranty Corporation Structural Problems Limit Agency's 
Ability to Protect Itself from Risk, GAO-05-360T. Washington, D.C.: 
March 2, 2005. 

Private Pensions: Airline Plans' Underfunding Illustrates Broader 
Problems with the Defined Benefit Pension System. GAO-05-108T. 
Washington, D.C.: October 7, 2004. 

Pension Plans: Additional Transparency and Other Actions Needed in 
Connection with Proxy Voting. GAO-04-749. Washington, D.C.: August 10, 
2004. 

Private Pensions: Publicly Available Reports Provide Useful but Limited 
Information on Plans' Financial Condition. GAO-04-395. Washington, 
D.C.: March 31, 2004. 

Private Pensions: Timely and Accurate Information Is Needed to Identify 
and Track Frozen Defined Benefit Plans. GAO-04-200R. Washington, D.C.: 
December 17, 2003. 

Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance 
Program Faces Significant Long-Term Risks. GAO-04-90. Washington, D.C.: 
October 29, 2003. 

Private Pensions: Changing Funding Rules and Enhancing Incentives Can 
Improve Plan Funding. GAO-04-176T. Washington, D.C.: October 29, 2003. 

Pension Benefit Guaranty Corporation: Long-Term Financing Risks to 
Single-Employer Insurance Program Highlight Need for Comprehensive 
Reform. GAO-04-150T. Washington, D.C.: October 14, 2003. 

Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance 
Program Faces Significant Long-Term Risks. GAO-03-873T. Washington, 
D.C.: September 4, 2003. 

Options to Encourage the Preservation of Pension and Retirement 
Savings: Phase 2. GAO-03-990SP. Washington, D.C.: July 29, 2003. 

Private Pensions: Participants Need Information on Risks They Face in 
Managing Pension Assets at and during Retirement. GAO-03-810. 
Washington, D.C.: July 29, 2003. 

Private Pensions: Process Needed to Monitor the Mandated Interest Rate 
for Pension Calculations. GAO-03-313. Washington, D.C.: February 27, 
2003. 

Answers to Key Questions About Private Pension Plans. GAO-02-745SP. 
Washington, D.C.: September 18, 2002. 

FOOTNOTES

[1] This figure represents the excess of the net present value of 
PBGC's single-employer program's future benefit payments to 
participants of terminated plans, plus expenses, over the program's 
assets, plus anticipated losses from probable future terminations. The 
$23.3 billion deficit for fiscal year 2004 already includes the recent 
takeover by PBGC of several United Airlines pension plans. 

[2] The recent downgrading of the credit ratings for Ford and General 
Motors to non-investment grade status is likely to raise this $96 
billion figure significantly. 

[3] For key legislative changes that have affected the single-employer 
program, see GAO, Pension Benefit Guaranty Corporation: Single-Employer 
Pension Insurance Program Faces Significant Long-Term Risks, GAO-04-90 
(Washington, D.C.: Oct. 29, 2003), appendix II. 

[4] The AFC comprises different additional charges for specific 
underfunded plan liabilities, including the deficit reduction 
contribution, or DRC. Because the AFC combines the DRC with other 
charges and offsets, we refer to the AFC, instead of the DRC, 
throughout this report as the "bottom line" additional charge that some 
underfunded plans owe. 

[5] Previously reported reforms include strengthening funding rules 
applicable to poorly funded plans; modifying PBGC single-employer 
program guarantees; restructuring PBGC premiums; and improving the 
availability of information about plan investments, termination funding 
status, and program guarantees. Several variations of reform were 
discussed within each reform option. For further information, see GAO-
04-90. 

[6] For further information on the challenges facing PBGC, see GAO, 
Pension Benefit Guaranty Corporation Single-Employer Pension Insurance 
Program: Long-Term Vulnerabilities Warrant High-Risk Designation, GAO-
03-1050SP (Washington, D.C.: Jul. 23, 2003), and High-Risk Series: An 
Update, GAO-05-207 (Washington, D.C.: Jan. 2005). 

[7] See GAO, 21st Century Challenges: Re-Examining the Base of the 
Federal Government, GAO-05-325SP (Washington, D.C.: Feb. 2005). 

[8] Form 5500 is a disclosure form that private sector employers with 
qualified pension plans are required to file with the Internal Revenue 
Service (IRS), Labor's Employee Benefit Security Administration (EBSA), 
and PBGC. IRS administers and enforces tax code provisions concerning 
private pension plans, EBSA enforces ERISA requirements regarding 
disclosure and other issues, and PBGC insures the benefits of 
participants in most private sector defined benefit pension plans that 
are eligible for preferential tax treatment. 

[9] These 100 plans are not a "closed group." For example, a plan that 
is one of the 100 largest plans in one year may not be in the sample of 
plans if its liabilities are not in the 100 largest plans for other 
years. Twenty-five plans are in the sample every year from 1995 to 
2002, and 51 plans are in at least 7 of the 8 years of the sample. From 
1995 to 2002 we witness 187 distinct plan identifiers called the 
employee identification number (EIN) and plan identification number 
(PIN). However, the actual number of completely unrelated plans in our 
sample may be lower than the 187 reported because a number of plan 
sponsors in our sample merged or changed names. For various reasons, 
EINs and PINs used to identify Form 5500 filings can change throughout 
the life cycle of a plan. These changes can occur because of changes in 
corporate structure, the sale of a division or plant to another firm, 
or filer error. 

[10] Lifetime annuities may also offer the option of continuing 
payments to a survivor after the participant's death. Some DB plans 
also offer the option of taking benefits as a lump-sum payment. For 
more on pension dispositions, see GAO, Private Pensions: Participants 
Need Information on Risks They Face in Managing Pension Assets at and 
during Retirement, GAO-03-810 (Washington, D.C.: Jul. 29, 2003). In 
recent years, some sponsors have converted their traditional DB plans 
to so-called hybrid, or cash balance, plans. Cash balance plans are a 
form of defined benefit plan that determines benefits on the basis of 
hypothetical individual accounts and commonly offer a lump-sum feature. 
For more information on cash balance plans, see GAO, Private Pensions: 
Implications of Conversions to Cash Balance Plans, HEHS-00-185 
(Washington, D.C.: Sept. 29, 2000), and Cash Balance Plans: 
Implications for Retirement Income. HEHS-00-207 (Washington, D.C.: 
Sept. 29, 2000). 

[11] 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. 

[12] Experience gains and losses reflect, among other things, the 
difference between actual asset performance and the assumed rates of 
return on assets for the plan, as reported in previous years. 

[13] Plans may amortize experience gains or losses over a 5-year 
period. Changes in the terms of the plan arising from plan amendments 
may be amortized over a 30-year period. Thus, these events continue to 
affect the FSA and plan funding for several years after they occur. 

[14] The rate used to calculate current liability has usually been 
based on the 30-year Treasury bond rate, with the allowable range above 
and below the 4-year weighted average varying in different years. The 
Pension Funding Equity Act of 2004 replaced the Treasury bond rate with 
the corporate index for plan years 2004 and 2005. See IRC Section 
412(b)(5)(B)(ii)(II). For further discussion of rates used to discount 
pension liabilities, see GAO, Private Pensions: Process Needed to 
Monitor the Mandated Interest Rate for Pension Calculations, GAO-03-313 
(Washington, D.C.: Feb. 27, 2003). 

[15] 26 U.S.C. 412(c)(2)(A). 

[16] Actuarial asset values cannot be consistently above or below 
market, but in a given year may be anywhere from 80 to 120 percent of 
the market asset level. 

[17] 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. Sponsors are required 
to provide PBGC with termination liability information if, among other 
things, the aggregate unfunded vested benefits of plans maintained by 
the contributing sponsor and the members of its controlled group exceed 
$50 million. See 29 U.S.C. 1310. For further discussion of current 
versus termination liability, see GAO-04-90, appendix IV. 

[18] A single-employer plan may be subject to an AFC in a plan year if 
plan assets fall below 90 percent of current liabilities. However, 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. To determine whether the AFC applies, the IRC requires 
sponsors to calculate current liabilities using the highest interest 
rate allowable for the plan year. See 26 U.S.C. 412(l)(9)(C). 

[19] Some DB plans are not covered by PBGC insurance; for example, 
plans sponsored by professional service employers, such as physicians 
and lawyers, with 25 or fewer active participants. 

[20] The termination of a fully funded DB plan is called a standard 
termination. Plan sponsors may terminate fully funded plans by 
purchasing a group annuity contract from an insurance company, under 
which the insurance company agrees to pay all accrued benefits, or by 
paying lump-sum benefits to participants if permissible. The 
termination of an underfunded plan, termed a distress termination, is 
allowed if the plan sponsor requests the termination and the sponsor 
satisfies other criteria. Alternatively, PBGC may initiate an 
"involuntary" termination. PBGC may institute proceedings to terminate 
a plan if the plan has not met the minimum funding standard, the plan 
will be unable to pay benefits when due, a reportable event has 
occurred, or the possible long-run loss to PBGC with respect to the 
plan may reasonably be expected to increase unreasonably if the plan is 
not terminated. See 29 U.S.C. 1342(a). 

[21] This guarantee level applies to plans that terminate in 2005. The 
amount guaranteed is adjusted (1) actuarially for the participant's age 
when PBGC first begins paying benefits and (2) if benefits are not paid 
as a single-life annuity. Because of the way ERISA allocates plan 
assets to participants, certain participants can receive more than the 
PBGC guaranteed amount. 

[22] The guaranteed amount of the benefit amendment is calculated by 
multiplying the number of years the benefit increase has been in 
effect, not to exceed 5 years, by the greater of (1) 20 percent of the 
monthly benefit increase calculated in accordance with PBGC regulations 
or (2) $20 per month. See 29 C.F.R. 4022.25(b). 

[23] For more on PBGC guarantee limits, see Pension Benefit Guaranty 
Corporation, Pension Insurance Data Book 1999 (Washington, D.C., Summer 
2000), pp. 2-14. 

[24] The additional premium equals $9.00 for each $1,000 (or fraction 
thereof) of unfunded vested benefits. However, no such premium is 
charged for any plan year if, as of the close of the preceding plan 
year, contributions to the plan for the preceding plan year were not 
less than the full funding limitation for the preceding plan year. 

[25] PBGC has available a $100 million line of credit from the U.S. 
Treasury for liquidity purposes if funds generated from premium 
receipts and investment activities are insufficient to meet operating 
cash needs in any period. However, while PBGC is a government 
corporation under ERISA, it is not backed by the full faith and credit 
of the federal government. For projections of the magnitude and timing 
of insolvency of PBGC's single employer program, see, for example, 
"PBGC: Updated Cash Flow Model from COFFI," Center on Federal Financial 
Institutions (COFFI) (Washington, D.C.: Nov. 18, 2004). 

[26] GAO 04-90. 

[27] See GAO-04-325SP. 

[28] See http://www.dol.gov/ebsa/pdf/SEPproposal2.pdf. Also see GAO-04-
90, appendix III, for more discussion of the Administration's earlier 
pension reform proposal, announced on July 8, 2003. 

[29] An underfunded plan does not necessarily indicate that the sponsor 
is unable to pay current benefits. Underfunding means that the plan 
does not currently have enough assets to pay all accrued benefits, a 
portion of which will be paid in the future, under the given actuarial 
assumptions about asset rate of return, retirement age, mortality, and 
other factors that affect the amount and timing of benefits. 

[30] See Board of Governors of the Federal System, "Flow of Funds 
Accounts of the United States," Table L.119.b, Dec. 9, 2004. This 
approximation likely understates stock holdings as a share of pension 
assets, as DB plans also held assets in mutual fund shares, which may 
also contain stocks. 

[31] Generally, a lower interest rate will raise plan liabilities, 
because a lower rate implies a lower rate of return on plan assets, 
requiring a higher level of assets to pay for benefits. However, in 
calculating current liabilities, the IRC allowed plans to use an 
interest rate above the benchmark 4-year weighted average, possibly 
offsetting the effects of lower rates on current liability. For 
example, sponsors could pick a rate up to 105 percent of the weighted 
average 30-year Treasury rate for plans in 1999; in 2002, this upper 
range was changed to 120 percent of the weighted average. See 26 U.S.C. 
412(b)(5)(B). 

[32] In 1987, the permissible range was not more than 10 percent above, 
and not more than 10 percent below, the weighted average of the rates 
of interest on 30-year Treasury bond securities during the 4-year 
period ending on the last day before the beginning of the plan year. 
The top of the permissible range was gradually reduced by 1 percent per 
year, beginning with the 1995 plan year, to not more than 5 percent 
above the weighted average rate effective for plan years beginning in 
1999. The top of the permissible range was increased to 20 percent 
above the weighted average rate for 2002 and 2003. For 2004 and 2005, 
the Congress changed the reference rate from the 30-year Treasury bond 
rate to a rate based on long-term investment-grade corporate bonds, and 
reset the allowable range for plans to 90 to 100 percent of this rate. 

[33] 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. 

[34] Figures are in 2002 dollars. The $97 million in contributions 
includes contributions from both employers and employees, although the 
vast majority of contributions come from employers. For 1995, the data 
set contains only employer contributions. 

[35] Minimum required annual funding equals annual total FSA charges, 
less net amortization credits and interest applied to these 
amortization credits. 

[36] Full funding limitation rules set a ceiling for minimum annual 
funding requirements for a plan each year, based on the plan's 
liabilities. 

[37] Some experts argue that since a pension plan represents a long- 
term financial commitment between a firm and its employees, and since 
current liability measures include many benefits that will not be paid 
until far in the future, it makes sense to smooth out year-to-year 
fluctuations rather than force each plan to balance assets and 
liabilities at all times. 

[38] There are investment techniques, such as purchasing fixed income 
assets whose payouts match the plan's expected payouts, that could make 
pension funding relatively predictable, even without FSA smoothing. One 
possible reason that such techniques are not widely used may be they 
are believed to be more expensive, over the long term than an asset 
allocation with significant equity investment exposure. 

[39] Conversely, a plan that experiences a large gain in assets must 
spread this gain over several years, which would make the plan appear 
to be more poorly funded that it actually was. 

[40] As with other funding rules, determining a plan's FFL is 
complicated. From 1995 to 2002, the FFL equaled the higher of (1) 90 
percent of the plan's current liability or (2) the lower of (a) the 
accrued plan liability or (b) 150 to 170 percent (depending on the 
year) of the current liability. As of the 2004 plan year, the 150 to 
170 percent measure no longer factors in the determination of the FFL. 
For our sample of plans, an average of 4 plans per year were above 150 
to 170 percent (depending on the year) of the current liability and had 
an FFL of zero. This means the sponsors of these plans were most likely 
unable to make additional contributions unless they paid an excise tax. 

[41] A plan's maximum deductible contribution is based on some of the 
same criteria as the FFL determination. A sponsor may also contribute 
up to the unfunded current liability level in each year. 

[42] For years after 2001, an employer may elect not to count 
contributions as nondeductible up to the full-funding limitation that 
is based on the accrued liability. Therefore, it could be possible for 
a sponsor to contribute more than the maximum deductible amount and 
still avoid the excise tax. See 26 U.S.C. 4972(c)(7). 

[43] For example, a sponsor of a plan that is 85 percent funded in 2003 
would be exempt from the AFC only if the plan's funding level exceeded 
90 percent in 2000 and 2001 or in 2001 and 2002. See 26 U.S.C. 
412(l)(9)(C). 

[44] Unique plans refer to the number of plans we observed with 
distinct plan identifiers called EINs and PINs. See footnote 9 for 
further information on why the actual number of completely unrelated 
plans in our sample may be lower than the 187 reported. 

[45] The AFC represents the required payment in excess of the regular 
ERISA minimum contribution, plus other possible additional charges. A 
plan owing an AFC must pay between 18 and 30 percent of the plan's 
"unfunded new liability," or liability incurred by the plan since the 
start of 1988, plus other charges based on the plan's normal cost and 
other unfunded liabilities. See 26 U.S.C. 412(l). 

[46] The number of plans per year in our sample sponsored by firms with 
a speculative grade rating is: 9 plans in 1995; 11 plans in 1996; 7 
plans in 1997; 7 plans in 1998; 8 plans in 1999; 8 plans in 2000; 13 
plans in 2001; and 12 plans in 2002. 

[47] Credit ratings are generally considered to be a useful proxy for a 
firm's financial health. A credit rating, generally speaking, is a 
rating service's current opinion of the creditworthiness of an obligor 
with respect to a financial obligation. It typically takes into 
consideration the creditworthiness of guarantors, insurers, or other 
forms of credit enhancement on the obligation and takes into account 
the currency in which the obligation is denominated. Moody's and 
Standard and Poor's (S&P) are two examples of well-known ratings 
services. We use S&P ratings throughout our report. S&P long-term 
credit ratings are divided into several categories ranging from AAA, 
reflecting the strongest credit quality, to D, reflecting the lowest. 
Ratings from AA to CCC may be modified by the addition of a plus or 
minus sign to show relative standing within the major rating 
categories. The term "investment grade" was originally used by various 
regulatory bodies to connote obligations eligible for investment by 
institutions such as banks, insurance companies, and savings and loan 
associations. Over time, this term gained widespread usage throughout 
the investment community. Ratings in the four highest categories, AAA, 
AA, A, BBB, generally are recognized as being investment grade. Debt 
rated BB or below generally is referred to as speculative grade. 
Sometimes the term "junk bond" is used as a more irreverent expression 
for this category of riskier debt. 

[48] Using reported market assets as the numerator of the funding 
percentage, the average funding of plans of sponsors that were rated as 
speculative grade was 17 percentage points lower on average than the 
funding level for all plans over the 1995-2002 period. 

[49] Six sponsors had plans that were assessed an AFC a total of 23 
times during the period. 

[50] In particular, a distress termination of a single employer's plan 
may occur if the employer meets one of the following conditions: (1) 
liquidation in bankruptcy or insolvency proceedings, (2) reorganization 
in bankruptcy or insolvency proceedings where bankruptcy court 
determines termination is necessary to allow reorganization, or (3) 
termination in order to enable payment of debts while staying in 
business or to avoid unreasonably burdensome pension costs caused by a 
decline of the employer's covered workforce. 

[51] For a discussion of moral hazard incentives, see GAO, Private 
Pensions: Airline Plans' Underfunding Illustrates Broader Problems with 
the Defined Benefit Pension System. GAO-05-108T (Washington, D.C.: Oct. 
7, 2004). 

[52] Criteria used for classifying a company as a reasonably possible 
include, but are not limited to, one or more of the following 
conditions: The plan sponsor is in Chapter 11 reorganization; funding 
waiver pending or outstanding with the IRS; sponsor missed minimum 
funding contribution; sponsor's bond rating is below-investment-grade 
for Standard & Poor's (BB+) or Moody's (Ba1); sponsor has no bond 
rating but unsecured debt is below investment grade; or sponsor has no 
bond rating, but the ratio of long-term debt plus unfunded benefit 
liability to market value of shares is 1.5 or greater. 

[53] Gross claims are the present value of future benefits less 
trusteed plan assets. 

[54] Speculative grade-rated issues tend to exhibit significant risk 
compared with other rated issues, even under short time horizons. 
Historical ratings indicate that speculative grade-rated plans are much 
more likely to default on obligations than investment grade-rated 
issues. For instance, over a 3-year period, the highest speculative 
grade (BB) rated issue defaults roughly 7 percent of the time, or 4.3 
times more frequently than the lowest investment grade rating (BBB). 
Further, even lower-rated speculative grade issuers tend to have even 
higher default probabilities over a 3-year period--defaulting 19 and 45 
percent of the time for B and CCC/C rated companies respectively. 
Typically, an issued rating does not change much from year to year. For 
example, looking at S&P ratings over the 1981-2003 period, AAA-rated 
issuers were still rated AAA 1 year later 88 percent of the time and B 
rated-issuers remained B 1 year later 74 percent of the time. 

[55] The Administration proposal moves in this direction by suggesting 
sponsors of different financial strength have different funding 
targets. See Strengthen Funding for Single Employer Pension Plans, U.S. 
Department of Labor, Employee Benefits Security Administration, 
February 7, 2005. 

[56] For more discussion, see GAO-04-325SP, pp. 54-57. 

[57] See GAO-04-90; GAO-05-108T; GAO, Pension Benefit Guaranty 
Corporation: Single-Employer Pension Insurance Program Faces 
Significant Long-Term Risks, GAO-03-873T (Washington, D.C.: Sept. 4, 
2003); Pension Benefit Guaranty Corporation: Long-Term Financing Risks 
to Single-Employer Insurance Program Highlight Need for Comprehensive 
Reform, GAO-04-150T (Washington, D.C.: Oct. 14, 2003); Private 
Pensions: Changing Funding Rules and Enhancing Incentives Can Improve 
Plan Funding, GAO-04-176T (Washington, D.C.: Oct. 29, 2003). 

[58] See GAO, Private Pensions: Participants Need Information on the 
Risks of Investing in Employer Securities and the Benefits of 
Diversification, GAO-02-943 (Washington, D.C.: Sept. 6, 2002); 
Retirement Income Data: Improvements Could Better Support Analysis of 
Future Retirees' Prospects, GAO-03-337 (Washington, D.C.: Mar. 21, 
2003); Private Pensions: Multiemployer Plans Face Short-and Long-Term 
Challenges, GAO-04-423 (Washington, D.C.: Mar. 26, 2004); and Private 
Pensions: Publicly Available Reports Provide Useful but Limited 
Information on Plans' Financial Condition, GAO-04-395 (Washington, 
D.C.: Mar. 31, 2004). 

[59] Each year, our sample contains a new set of 100 largest plans 
based on the plan liabilities in that year. That is, from year to year, 
the 100 largest plans will add and subtract plans from other years' 100 
largest plans. 

[60] In each year of data we matched the relevant December ratings 
issue for that year. Plans sponsored by a company subsidiary were given 
the rating of the parent unless the subsidiary had its own rating. 
Additionally, the same sponsor may sponsor a number of plans in the 
largest 100 plans for any given year. We observe a number of sponsors 
with multiple plans in any given year of our sample. 

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