lesser of the insufficiency or an amount equal to 30 percent of the employer's net worth.

Under these rules, employers that wanted to rid themselves of underfunded liabilities could simply terminate the plan, and the PBGC would be liable for benefits. The PBGC was in some cases prevented from recouping its liability from the employer, even if the employer was financially sound. The plan termination rules were amended to prevent such transferring of liabilities to the PBGC by the Single Employer Pension Plan Amendments Act (SEPPAĂ) and were modified further by the Pension Protection Act of 1987.

Under present law, a defined benefit plan with assets insufficient to provide for benefit liabilities can be terminated voluntarily by the employer only if the employer and members of the controlled group of the employer are in financial distress. In general, benefit liabilities are all fixed and contingent liabilities to plan participants and beneficiaries.

Following a distress termination, the PBGC pays out all benefits under the plan, including guaranteed benefits and those not guaranteed. The amount of benefits in excess of guaranteed benefits that are paid to plan participants depends on the level of plan funding and the amount the PBGC is able to recover from the employer. The employer is liable to the PBGC for the full amount of unfunded benefit liabilities.

Guaranteed benefits

The PBGC guarantees vested retirement benefits (other than those that vest solely on account of the plan termination), up to a maximum benefit of $2,437.50 per month in 1993. The dollar limit is indexed annually for inflation. The guarantee is reduced for benefits starting before age 65, and does not apply to certain types of ancillary benefits. In the case of a plan or a plan amendment that has been in effect for less than 5 years before a plan termination, the amount guaranteed is phased in by 20 percent a year.

Sources of PBGC funding

The PBGC is funded by assets in terminated plans, amounts recovered from employers who terminate underfunded plans, premiums paid with respect to covered plans, and investment earnings. All covered plans are required to pay a flat per-participant premium and underfunded plans are subject to an additional variable premium based on the level of underfunding.

As initially enacted in ERISA, covered plans were required to pay a flat premium to the PBGC of $1.00 per plan participant. The flat-rate per-participant premium has been increased several times since the enactment of ERISA, and is currently $19 per participant in 1993.

The variable rate premium was enacted by the Pension Protection Act of 1987. It was believed that underfunded plans should bear a greater burden than well-funded plans because they pose a greater risk of exposure to the PBGC. The amount of the variable rate premium is $9.00 per each $1,000 of unfunded vested benefits, up to a maximum of $53 per participant. Thus, the maximum total per-participant premium for an underfunded plan is $72 in 1993.

In general

B. Financial Status of the PBGC

As of September 30, 1991, the PBGC reported a deficit of $2.5 billion. This is an increase over the $1.9 billion deficit reported as of the end of the prior fiscal year. The PBGC experienced its largest losses in the history of the termination insurance program in the fiscal year ending September 30, 1991. The PBGC attributes these losses primarily to lower expected recoveries from employers in bankruptcy for plans added to PBGC's liabilities in 1990. The PBGC reports that the defined benefit plan system is healthy as a whole, but that some pension plans, primarily in the steel, automobile, tire, and airline industries, are underfunded by about $40 billion. Of this, the PBGC reports that about $13 billion is in plans sponsored by financially troubled companies.

The PBGC has estimated its future financial status under a variety of assumptions. The deficit could range from about $2.7 billion by the end of 2001 if losses are relatively low, to about $17.9 billion by the end of 2001 if losses are high. According to the PBGC, the estimate of a potential deficit of $17.9 is not a worst-case scenario. Hidden liabilities reflected

In a study released by the U.S. General Accounting Office (GAO) in December 1992,2 GAO reported that the 44 plans with the largest claims against the PBGC for calendar years 1986-88 had aggregate unfunded liabilities at termination of $2.7 billion. These unfunded liabilities were $990 million, or 58 percent, higher than the $1.7 billion in unfunded liabilities reported by the 44 plans on their last, pretermination annual filing with the IRS. GAO termed this additional unfunded liability as a "hidden liability" to the PBGC because it was not reported by plans before termination.

Hidden liabilities can result from several causes. Most of the $990 million in hidden liability reported in the GAO study was due to PBGC's higher estimate of plan liabilities as a result of PBGC's use of actuarial assumptions that were different than the assumptions used by plan sponsors. Hidden liabilities also can result because of the payment of shutdown 3 or special early retirement benefits, earlier-than-anticipated retirements, and PBGC's receipt of fewer assets than reported by the plans.

The PBGC takes its exposure to hidden liabilities into account in its financial statements.

2U.S. General Accounting Office, Hidden Liabilities Increase Claims Against Government Insurance Program (GAO/HRD-93-7), December 30, 1992.

3 Shutdown benefits are benefits payable only upon termination of the plan sponsor's business operations. Since this is generally assumed by plan actuaries to have a very small probability of occurring, shutdown benefits are only partially funded, at best.

III. PRESENT-LAW PENSION PLAN FUNDING

In general

REQUIREMENTS

ERISA and the Code impose both minimum and maximum defined benefit plan funding requirements. The minimum funding requirements are designed to provide at least a certain level of benefit security by requiring the employer to make certain minimum contributions to a defined benefit plan. The requirements recognize that, in an on-going plan, pension liabilities are generally a longterm liability. Thus, benefits are not required to be immediately funded, but can be funded over a long period of time.

The maximum funding limitations are designed to limit and allocate efficiently the loss of Federal tax revenue associated with the special tax treatment afforded qualified retirement plans. Thus, annual deductible contributions to a defined benefit plan are limited to an amount that is not significantly greater than the amount that would normally be necessary under the employer's long-term actuarial funding method.

The minimum and maximum funding requirements provide the employer considerable flexibility in determining the amount of the contribution that must, or can, be made in any given year. The minimum required or maximum permitted contribution that can be made depends on the funding method used by the plan and the actuarial assumptions used by the plan actuary.

In response to concerns about the financial status of underfunded pension plans, the minimum funding standards were modified, and special additional funding requirements were added for underfunded pension plans, by the Pension Protection Act of 1987.

The minimum and maximum funding requirements, and the special rules for underfunded pension plans, are discussed in detail below.

Minimum funding standard

In general

Under the Code and ERISA, certain defined benefit pension plans are required to meet a minimum funding standard for each plan year. As an administrative aid in the application of the funding standard, each defined benefit pension plan is required to maintain a special account called a "funding standard account" to which specified charges and credits (including credits for contributions to the plan) are to be made for each plan year. If, as of the close of a plan year, the account reflects credits equal to or in excess of charges, the plan is treated as meeting the minimum funding standard for the year. Thus, as a general rule, the minimum contribution for a plan year is determined as the amount by

which the charges to the account would exceed credits to the account if no contribution were made to the plan.

Accumulated funding deficiencies

If, as of the close of any plan year, charges to the funding standard account exceed credits to the account, then the excess is referred to as an "accumulated funding deficiency." Unless a minimum funding waiver is obtained, an employer who is responsible for contributing to a plan with an accumulated funding deficiency is subject to a 10-percent nondeductible excise tax (5 percent in the case of a multiemployer plan) on the amount of the deficiency. If the deficiency is not corrected within the "taxable period", then an employer who is responsible for contributing to the plan is also subject to a nondeductible excise tax equal to 100 percent of the deficiency. The taxable period is the period beginning with the end of the plan year in which there is a deficiency and ending on the earlier of (1) the date of a mailing of a notice of deficiency with respect to the 10-percent tax or (2) the date on which the 10-percent tax is assessed by the Internal Revenue Service (IRS). If the employer responsible for contributing to the plan is a member of a controlled group, each member of the group is jointly and severally liable for the excise tax.

For example, if the balance of charges to the funding standard account of a plan for a year would be $200,000 without any contributions, then a minimum contribution in that amount would be required to meet the minimum funding standard for the year to prevent an accumulated funding deficiency. If the total contribution is not made, then the employer would be subject to an excise tax equal to 10 percent of the deficiency for the year. If the deficiency were not corrected within the specified period, then the 100-percent excise tax would be imposed on such employer (or employers).

Funding methods

In general.-A defined benefit plan is required to use an acceptable actuarial cost method to determine the balance in its funding standard account for a year. Generally, an actuarial cost method breaks up the cost of benefits under the plan into annual charges consisting of two elements for each plan year. These elements are referred to as (1) normal cost, and (2) supplemental cost.

Normal cost.-The normal cost for a plan for a year generally represents the cost of future benefits allocated to the year by the funding method used by the plan for current employees and, under some funding methods, for separated employees. Specifically, it is the amount actuarially determined that would be required as a contribution by the employer to maintain the plan if the plan had been in effect from the beginning of service of then included employees and if the costs for prior years had been paid, and all assumptions as to interest, mortality, time of payment, etc., had been fulfilled. The normal cost will be funded by future contributions to the plan (1) in level dollar amounts, (2) as a uniform percentage of payroll, (3) as a uniform amount per unit of service (e.g., $1 per hour), or (4) on the basis of the actuarial present values of benefits accruing under the plan in particular plan years.

Supplemental cost.-The supplemental cost for a plan year is the cost of future benefits allocated to the year that would not be met by normal costs and employee contributions. The most common supplemental cost is that attributable to past service liability, which represents the cost of future benefits under the plan (1) on the date the plan is first effective, or (2) on the date a plan amendment increasing plan benefits is first effective. Under some funding methods, there is no past service liability component.

Other supplemental costs may be attributable to net experience losses, changes in actuarial assumptions, and amounts necessary to make up funding deficiencies for which a waiver was obtained. Supplemental costs must be amortized over a range of years specified under the Code and ERISA, which may be shorter or longer than the period over which normal costs are amortized under the plan's funding method.

Acceptable methods.-Normal cost and supplemental cost are key elements in computations under the minimum funding standard. Although these costs may differ substantially, depending upon the actuarial cost method used to value a plan's assets and liabilities, they must be determined under an actuarial cost method permitted by ERISA. ERISA enumerates six acceptable actuarial cost methods and provides that additional methods may be permitted under Treasury regulations. Normal costs and supplemental costs under a plan are computed on the basis of an actuarial valuation of the assets and liabilities of a plan. An actuarial valuation is required once every plan year. More frequent valuations may be required by the IRS.

Charges and credits to the funding standard account

In general.-Under the minimum funding standard, the portion of the cost of a plan that is required to be paid for a particular year depends upon the nature of the cost. For example, the normal cost for a year is generally required to be funded currently. On the other hand, costs with respect to past service (for example, the cost of retroactive benefit increases), experience losses, and changes in actuarial assumptions, are spread over a period of years.

Normal cost.-Each plan year, a plan's funding standard account is charged with the normal cost assigned to that year under the particular acceptable actuarial cost method adopted by the plan. The charge for normal cost will require an offsetting credit in the funding standard account. Usually, an employer contribution is required to create the credit.

For example, if the normal cost for a plan year is $150,000, the funding standard account would be charged with that amount for the year. Assuming that there are no other credits in the account to offset the charge for normal cost, an employer contribution of $150,000 will be required for the year to avoid an accumulated funding deficiency.

Past service liability.-There are 3 separate charges to the funding standard account that may arise as the result of past service liabilities. The first applies to a plan under which past service liability has increased due to a plan amendment made after January 1, 1974; the second applies only to a plan that came into existence after January 1, 1974; and the third applies only to a plan in exist