present-law minimum funding standards exposes plan participants and the PBGC to excessive risk. Under present law, plans with unfunded liabilities are permitted to amortize the shortfall over a number of years that varies with the cause of the underfunding. This period can be as long as 40 years. As a result, the funded status of a plan can deteriorate even if the minimum funding requirements are fully satisfied. Strengthening the minimum funding rules would limit the ability of employers to delay or avoid funding obligations. Stricter funding rules would not come without a price, however. Stricter rules would have the greatest effect on underfunded plans in declining and troubled industries, possibly forcing some companies into bankruptcy. Tighter restrictions could also affect companies that in a cyclical downturn may be unable to meet strict funding standards during an unprofitable period. (Presumably, though, IRS funding waivers could be preserved to accommodate these situations.) Even some healthy companies will object to additional restrictions on funding flexibility because of the increased costs that will sometimes result. Income tax revenues would decline because companies would be required to increase the amount of deductible contributions to their plans, and because subsequent earnings on the additional contributions would be excludable from income. Full funding limit In a similar vein, pension funding might be improved by easing restrictions on maximum funding levels. This way, plans might be able to contribute enough during profitable periods to make up for any shortfalls during economic downturns. Some have suggested that repeal of the limit based on 150-percent of current liability (added in 1987) 12 would be beneficial in this regard. According to a 1991 Treasury Report, 13 however, the effect on funding levels of the current liability limit is minimal. Treasury found that the decrease in funding levels resulting from the limit does cause a small increase in the risk to plan participants and the PBGC because of lower funding rates. However, the limit affects only well-funded plans, and only by relatively small amounts. The report concludes that the current liability limit is likely to have an insignificant effect on employee benefit security. Hidden liabilities 14 The PBGC's exposure could be limited by reducing its hidden liabilities. In a study released in January 1993,15 GAO reported that the PBGC's exposure to unfunded liabilities is much larger than plans have indicated on their annual reports. As a consequence, when a pension plan terminates with insufficient assets, the PBGC is likely to absorb unfunded liabilities considerably greater than the plan reported (thus the term "hidden liability"). According to 12 For background on this limit. See Part III, above (“Funding limits"). 13 Department of the Treasury, Report to Congress on the Effect of the Full Funding Limit on Pension Benefit Security, May 1991. 14 See Part II.B., above, for a general description of hidden liabilities. 15 U.S. General Accounting Office, Hidden Liabilities Increase Claims Against Government Insurance Program (GAO/HRD-93-7), December 30, 1992. GAO, the PBGC has few tools under present law to control its exposure to these hidden liabilities. Critics assert that the amount of its liabilities the PBGC overstates because the actuarial assumptions the corporation uses to calculate such liabilities are unrealistic. Thus, one way to reduce hidden liabilities would be for the PBGC to use more realistic assumptions. The PBGC acknowledges its use of a lower-than-market rate of interest, but defends this practice on the grounds that it is necessary to offset the effect of the relatively high mortality rates it assumes. The PBGC recently proposed 16 to revise its mortality and interest rate assumptions to reflect recent actuarial practice. Plan sponsors also could be required to use actuarial assumptions that more accurately reflect expected future liabilities. For example, interest rate assumptions used to calculate plan liabilities could be regulated more strictly. Under present law, actuaries hired by plan sponsors are free to select, within a typical range of about 2 percentage points, the interest rate to be used by the plan. GAO found that a 1 percentage point increase in the interest rate assumption will generally lead to about a 10- to 20-percent decrease in calculated plan liabilities. Thus, a rate selected from the high end of the range can result in calculated liabilities significantly lower than a rate from the low end of the range. Plan sponsors that use a higher rate can reduce the amount of required contributions, possibly leading to underfunding and a hidden liability to the PBGC. Better reporting and internal plan audits by independent accountants also could reduce hidden liabilities. GAO has recommended that the Congress amend ERISA to require full-scope audits of pension plans, and to require plan administrators and independent accountants to report how effectively the internal controls of a plan protect plan assets. 17 These internal controls should be a key safeguard in protecting plan participants and the PBGC. The Congress could address the problem of hidden liabilities that arise as a result of special shutdown benefits paid when an employer ceases operations. Shutdown benefits are poorly funded because they are not fully valued by plan actuaries when calculating the plan's liabilities. Because plans often terminate shortly after shutdown benefits begin, sponsors do not have time to fund the benefits once they accrue, and the PBGC receives a hidden liability. Many observers view shutdown benefits as a particularly egregious abuse of the pension guarantee system. Since such benefits are payable only upon termination of all or a part of the sponsor's operations, sponsors know that responsibility for making payments probably will be borne by the PBGC. Critics argue that such benefits should not be insured by the PBGC. However, even if not insured, shutdown benefits increase plan liabilities because they drain plan assets that would otherwise be used to pay regular, guaranteed, benefits. This practice would also have to be restricted in order to limit PBGC's exposure to potential excessive liabilities. 16 58 Fed. Reg. 5128 (January 19, 1993). 17 U.S. General Accounting Office, Improved Plan Reporting and CPA Audits Can Increase Protection Under ERISA (GAO/AFMD-92–14), April 9, 1992. |