GAO: Pension Reforms Mean Systemwide Reconsideration

March 2, 2005 ( - Problems in the defined benefit pension system should prompt Congress to reconsider the entire legal underpinning of the insurance system administered by the Pension Benefit Guaranty Corporation (PBGC).

Lawmakers would do well to rethink the whole notion of how the government backs private pensions, said David Walker, head of the Government Accountability Office (GAO), in testimony Wednesday before the House Subcommittee on Government Management, Finance, and Accountability.

“The long-term financial health of the PBGC and its ability to protect workers’ pensions is inextricably bound to the underlying change in the nature of the risk that it insures, and implicitly to the prospective health of the defined benefit system,” Walker testified. “Options that service to revitalize the defined benefit system could stabilize PBGC’s financial situation, although such options may be effective only over the long term. Our greater challenge is to fundamentally consider the manner in which the federal government protects the defined benefit pensions of workers in this increasingly risky environment.”

In FY 2004, PBGC’s single employer pension insurance program lost $12.1 billion and the program’s accumulated deficit jumped to $23.3 billion from $11.2 billion a year earlier. Underfunding in single employer plans exceeded $450 billion as of the end of FY 2004, according to the agency’s estimates.

Two key structural issues, according to Walker:

  • Current pension funding rules under the Employee Retirement Income Security Act (ERISA) and the federal tax code were not designed to make sure that plans have the means to meet their obligations if plan sponsors run into financial difficulties.
  • As a whole, premiums paid by plans sponsors have not properly reflected the risk the PBGC takes on. The current flat-rate premium system, unrelated to risk, results in large cost-shifting from financially troubled firms with underfunded plans to healthy firms with properly funded pensions.

“Accordingly,” Walker testified, “defined benefit plan sponsors, acting rationally and within the rules, have been able to turn significantly underfunded plans over to the PBGC, thus creating PBGC’s current deficit.”

Walker gave the agency kudos for:

  • creating The Pension Insurance Modeling System, in an attempt to better forecast its risk
  • pursuing its Early Warning Program through which it negotiates the best outcome with companies with underfunded plans
  • restructuring its investment strategy to cut its equity exposure to be better protected from market risks.

“However, despite these efforts, the agency, unlike other federal insurance programs, ultimately lacks adequate authority to effectively protect itself.” Walker said.   He pointed out, for example, that the FDIC, a bank insurance program can set its own premiums and adjust them every six months based on risk issues. FDIC can also reject applications from overly risky financial institutions, he said.

The GAO official said the presence of the PBGC’s safety net may actually work against it if plan sponsors take advantage of the financial backup. “The very presence of PBGC insurance may create certain perverse incentives that represent moral hazard – struggling plan sponsors may place other financial priorities above ‘funding up’ their pension plans because they know PBGC will pay guaranteed benefits,” Walker testified.