Senators Urged To Consider DB System Overhaul

March 11, 2003 (PLANSPONSOR.com) - The US defined benefit pension system desperately needs systematic reform as it struggles with an underfunding epidemic that now exceeds a record $300 billion among private companies.

That was a central theme of Capital Hill testimony before the US Senate Finance Committee, which is investigating how best to turn around the ailing pension system.

“We cannot over-emphasize the urgency of enacting this permanent, comprehensive reform nor the degree to which achieving this reform is related to stemming the decline in defined benefit plans,” said Henry Eickelberg. staff vice president for benefit programs for the General Dynamics Corporation, who appeared for the American Benefits Council. “Action is needed by late spring in order to convince struggling employers that help is on the way.”

Steven Kandarian, executive director of the Pension Benefit Guaranty Corp (PBGC), the federal pension insurer, told lawmakers that more than 270 companies informed the agency during 2002 that their plan had at least a $50-million underfunding problem   – more than three times the number doing so in any other year.

Stronger Funding Requirements

A good place to start getting the pension system’s house in order would be to beef up current funding requirements, the PBGC chief testified. “The funding targets are simply not high enough for the plans of companies at the greatest risk of termination,” Kandarian said. “Allowing companies to compute contribution requirements based on asset and liability numbers that are averages of prior years can further defer funding. Finally, there is nothing in the funding rules that requires companies with underfunded pensions to make annual cash contributions to the plan.”

However, Eickelberg rejected the notion that stricter funding guidelines are needed. “It makes absolutely no sense that companies were not able to provide a strong financial cushion in times of economic plenty, and it is counterproductive to the overall economic health of this country that companies that are struggling to put scarce capital to productive use in the current downturn are being saddled with exorbitant required pension contributions,” Eickelberg testified.  “The common sense approach would be to alter the pension funding rules so that employers can fund their plans in times of economic strength and weather economic downturns without imposition of extreme funding requirements.”

Kandarian also called for stricter disclosure rules about pension plans’ funding status. “For example, only participants in plans below a certain funding threshold receive annual notices of the funding status of their plans,” he testified.

The PBGC executive told senators that the agency is studying whether to abandon its current structure of insurance premiums paid by private-sector companies whose pensions the agency guarantees. Rather than the current system of basing payments on the number of participants and the dollar amount of underfunding, Kandarian said the agency is looking at whether to charge premiums based more of the risks posed by a particular plan.

A Warning About Doing Nothing

Absent reforms, Kandarian warned that the US defined benefit system could become an arena solely for the underfunded as financially stronger companies give into the cost pressures of running a defined benefit plan and more to another plan arrangement.

“The existence of the pension insurance programs creates moral hazard, tempting management and labor at financially troubles companies to defer their pension obligations, ” Kandarian testified. “This unfairly transfers the cost of underfunded pension plans to responsible companies and their workers. The financially strong companies at some point will have had enough, and will exit the defined benefit system, leaving only those which pose the greatest risk of claims. We need to make sure the incentives in the system are changed so this doesn’t happen.”

For his part, Eickelberg claimed a lack of employer choice and flexibility would drive companies away from DB plans. “The Council feels strongly that we must ensure that both traditional and hybrid defined benefit plans remain viable choices for employers so that companies can select the pension plan design most suited to the needs and wishes of their workforce,” he said. “Defined benefit plans offer unique advantages for employees, but without prompt action by Congress we fear these plans will increasingly disappear from the American pension landscape.”

Problems in the defined benefit system have, in turn, translated into severe woes for the PBGC, an ERISA-created agency designed to guarantee pension payments for private sector workers at ailing or bankrupt companies. Kandarian reminded lawmakers that in 2002 the agency’s single employer program went from a $7.7 billion surplus to a $3.6 billion deficit – an $11.3-billion loss in one year. Chiefly driving that trend were severe and continuing pension problems in the steel and airline industries, Kandarian said. The two industries have accounted for 70% of PBGC claims since 1975, but fewer than 5% of insured participants (See  PBGC Bottom Line Buffeted by “Perfect Storm” ).

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