GAO: Reform DB Funding Rules

May 31, 2005 (PLANSPONSOR.com) - While pondering the pending proposals for reform of the nation's defined benefit pension system, Congressional lawmakers need to pay particular attention to strengthening plan funding rules, a Congressional watchdog group asserted Tuesday.

>In a report entitled “Private Pension: Recent Experiences of Large Defined Benefit Plans IllustrateWeaknesses in Funding Rules,” the Government Accountability Office (GAO) said that current pension rules have allowed some plan sponsors to avoid plan contributions even if their plan was underfunded.

>Because of the technicalities involving the additional funding charge (AFC) provision in federal pension law and the funding standard amount (FSA) rule – both having to do with when and how underfunded plans have to get a plan sponsor contribution – some companies have been able to understate their plan’s true financial picture, GAO investigators charged.

>Specifically, the GAO claimed that congress should strengthen the AFC provision, perhaps by raising the threshold levels of funding that trigger the AFC so that any sponsor with a plan less than 90% funded would have to make additional contributions. Lawmakers could also consider a gradual phase-in of the AFC for plans that are underfunded between 90% and 100% of current liability, according to the report.

The GAO also recommended Congress consider l imiting 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,” investigators wrote in the report. “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.”

Understating the Problem

Also, to back up its assertion that some severely ailing plans were able to file annual reports vastly understating the size of their financial problems, the GAO pointed to the Bethlehem Steel plan which the agency said had reported in 2002 that its plan was 85.2% 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 Pension Benefit Guaranty Corporation (PBGC), the nation’s private-sector pension insurer, suffered a $3.7 billion loss as a result of that termination, its largest ever at the time (See  PBGC Takes On Its Biggest Liability Yet ).

>Similarly, the agency said that the LTV Steel Company reported that its pension plan for hourly employees was over 80% funded on its Form 5500 filing for plan year 2001. When this plan terminated in March 2002, it had assets equal to 52% of benefits, a shortfall of $1.6 billion.

“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,” the report said. “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.”

>In fact, while saying that most of the large DB plans were properly funded between 1995 and 2002, the GAO admitted that the extent of the problem with other plans could be greater than it might appear from the official reports.

“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 (in 2002),” the GAO said. “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% of plans that were less than 100% funded.”

>The GAO acknowledged that some of its suggested reforms may prompt companies currently sponsoring a DB plan to freeze or terminate it.

"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 tradeoff 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 report concluded. "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."

>Administration officials used the GAO report's release Tuesday to once again call for lawmakers to enact the Bush Administration's pending pension reform proposals (See  Chao Releases Administration DB Reform Proposal ).

"The funding-rule weaknesses highlighted in this report are the very ones the Administration's reform proposal would address," said PBGC Executive Director Bradley Belt, in a statement. "When pension plans are underfunded, they need to be replenished with real dollars, not with phantom 'credit balances.' Current-law 'smoothing' practices make pension plans look financially healthier than they really are. The GAO report confirms what we have been saying all along: The rules must be changed to ensure that companies keep the pension promises they have made to their workers."

>US Representative John Boehner (R-Ohio) likewise applauded the GAO's effort. "There is little doubt that today's outdated pension rules fail to protect the interests of workers and retirees and this report illustrates that fact once again," said Boehner, in a statement.  "Today's outdated rules also put the taxpayers at significant risk of a possible multi-billion dollar bailout of the PBGC if the agency's financial condition continues to worsen."

>The GAO report is  here . More information about the Administration's pension proposal is  here .

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