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 Impact on Contributions, Funded Ratios,and Claims against the Pension Insurance Program
 
of the
Administration’s Pension Reform Proposal
Pension Benefit Guaranty Corporation
Policy, Research & Analysis Department
White PaperApril 6, 2005
 
Introduction
ThispaperreportstheresultsofaseriesofsimulationsoftheeffectsthattheAdministration’ssingle-employerdefinedbenefitpensionfundingreformproposalandcurrentlawwillhaveonthefuturevaluesofthreekeyvariablesinthesingleemployerpensionsystem:requiredminimumcontributions,planfundinglevelsandclaimsagainstthepensioninsuranceprogram.Theresultsofsimulationsforanumberofeconomicscenariosarepresented.Thescenariosdiscussedinthispaperwerechosentoreflecttheperformanceoftheproposaloverawiderangeofgenericeconomicconditions.Noneofthescenariosshouldbeconsideredpredictionsorforecastsoffutureeconomicperformance.Additionally,theprogramusedtodevelopthesesimulationskeepsthepopulationofdefinedbenefitpensionplansandtheactiveparticipantsinthoseplansroughlyconstantovertime.Forthesereasons,theresultsdiscussedinthepaperarenotdirectlycomparabletoresultsthatmightbegeneratedbyanalyzingtheproposal’seffectsunderanyspecificforecastoffutureeconomicconditionsorpathofdefinedbenefitpensionplanparticipation.Allsimulationscoverthe10-yearperiodfrom2006through2015forthesingle-employersystemasawholeanddonotattempttomeasuretheeffectsofeithertheproposalorcurrentlawonindividualpensionplansorspecificindustries.Theanalysissuggeststhatunderthescenariosanalyzedplanfundingandcontributionswillbehigherandclaimswillbeloweriftheproposalisenactedthanwillbethecaseifcurrentfundingrulesremaininplace.
 
Theresultsinthispaperreflectonlyhowtheproposedfundingrulerulesaffectthepensionsystemunderanassumptionthatplansponsorscontinuetobehaveastheydoundercurrentlaw.Formodelingpurposes,sponsorsareassumedtomakeminimumrequiredcontributionseachyear.Theseresultsdonotreflecttheeffectsofsomecriticalcomponentsoftheproposalincludingthedirectandincentiveeffectsofbenefitrestrictionsandtheincentive
 
effectsoftheproposedsystemofPBGCpremiums.Theproposalprovidesplansponsorswithboththetoolsandincentivestosmoothcontributionsbyfundingabovetheminimumduringgoodtimes.Projectedminimumcontributionsdonotreflectthisbehavior—thatis,sponsorsarenotassumedtotakeadvantageofnewrulesthatallowsponsorstobuildfundingcushionsingoodeconomictimes.Thepaperdoesdiscussastylizedexampleofhowarepresentativesponsormightusetheserulestomakethepathofrequiredcontributionslessvolatileovertime.

Pension Funding Has Been Inadequate
Manysingle-employerdefinedbenefitpensionplansareseriouslyunderfunded,asituationthatthreatensthelong-termviabilityofthepensionsystemifnotcorrected.Totalunderfundinginthesystemiscurrentlyestimatedtoexceed$450billion.Anumberoflargepensionplanshaveterminatedinrecentyearswithsignificantunderfundingofpromisedpensionsresultinginaprecipitousdeclineinthenetpositionofthesingle-employerinsuranceprogram.Theprogram,whichhada$7.7billionsurplusin2001,hada$23.3billiondeficitattheendof2004.Planterminationsoftenhaveseriousconsequencesforplanparticipants.Forexample,BethlehemSteel’splanhadonlyabout$3.5billioninassetstocoveralmost$8billionofpromisedbenefitswhenitterminated.Whiletheinsurancesystemwillpayforalmost$4billioninunfundedbenefits,BethlehemretireeswillreceivehalfabilliondollarslessinbenefitsthanpromisedbecauseofthelegallimitsofPBGC’sguarantee.Someparticipantswillreceivelessthanhalfoftheirpromisedbenefit.Ifplanunderfundingandlargeclaimsagainsttheinsuranceprogramareallowedtopersist,theburdenonremainingplansponsors,whosepremiumsaretheprimarysourceofrevenuetopayunfundedbenefits,willcontinuetoincrease.Ifthatburdenbecomestoogreat,sponsorsmayasktheCongresstoauthorizeabailoutofthesystembyU.S.taxpayers.
The Administration’s Proposal to Reform Pension Funding
TheAdministration’spensionproposalisdesignedtoprotectparticipant’sbenefitsandimprovethepositionoftheinsuranceprogrambyprovidingbetterincentivesforsponsorstomaintainresponsiblefundingthanexistundercurrentlaw.Pensionunderfundingismorethan$450billionnotwithstandingcomplianceofplansponsorswithcurrentfundingrules—atestamenttotheneedforreform.Currentfundingrulesaresimplyinadequatetoensureproperfundingofpensionpromises.Theproposalwillreducethechancesthatfutureretireeswillsufferlossesinearnedpensionbenefitsandwillrestorethehealthofthepensioninsuranceprogram.Thesegoalswillbeaccomplishedbycorrectingstructuralflawsinthefundingrules.Keyfeaturesoftheproposalincludeprovisionsthatwill:
•
 
Measureplanassetsandliabilitiesaccurately.
•
 
Ensureadequatefundingbyestablishingfundingtargetsthatequalthefullvalueofaccruedbenefits.
 2
 
•
 
Increaselimitsondeductiblecontributionsinordertoallowsufficientadvancefundingbyplansingoodeconomictimes,toreducesubstantialincreasesinminimumrequiredcontributionsinbadeconomictimes.
•
 
Reducemoralhazardbyrestrictingfinanciallytroubledcompanieswithunderfundedplansfrommakingnewbenefitpromisestheycannotkeep.
•
 
ReformPBGCpremiumssothattheybetterreflectaplan’sriskandensurethepensioninsurancesystem’sfinancialsolvency.ForadetaileddescriptionoftheAdministration’spensionreformproposal,seetheDepartmentofLabor’swebsiteathttp://www.dol.gov/ebsa/pdf/SEPproposal2.pdf .
Methodology
ThispapercomparestheimpactofcurrentlawandtheAdministration’sfundingreformproposalonminimumcontributionrequirements,fundedratios,andexpectedclaimsagainstthepensioninsuranceprogram.Comparativeresultsareshownfora“baselineeconomy”(aneconomywhereinterestrates,equityreturns,andothervariablesaresetatapproximatelytheirhistoricalaverages),forthetypeofeconomythatprevailedfrom1995through2004(whichinitslatteryearsincludedthe“perfectstorm”oflowinterestratesanddecliningequityvalues),and500scenarioschosenatrandomusingastochasticmodelingapproach.TheanalysiswasperformedusingthePBGC’sPensionInsuranceModelingSystem(PIMS).PIMShasadatabasewithdetailedinformationonabout400actualpensionplans,sponsoredbynearly300firms.Theseplansrepresentabout50percentoftheliabilitiesandunderfundinginthedefinedbenefitsystem.Themodelprojectsvariouseconomicscenariosoverthe10-yearperiodfrom2006through2015andmeasurestheimpactofeachscenarioontheplansinthedatabaseforeachyearofthe10-yearperiod.Someoftheseeconomicscenariosaredeterministic,withinterestrates,equityreturns,andothervariablessettomimicaparticulareconomicperiod(suchasthe1995through2004period).Someofthescenariosarestochastic,withinterestrates,equityreturns,andothervariablesallowedtofluctuaterandomly(withincertainboundsbasedonhistoricalexperience).Inboththedeterministicandstochasticscenarios,PIMSextrapolatestheresultsofthesimulationstotheuniverseofsingle-employerplans.ThePIMSmodelisnotpredictive.Thatis,itdoesnotprovideasinglebestestimateoffutureevents.Whenusedinastochasticmode,PIMSprovidesarangeofpossiblefutureoutcomesandquantifiesthelikelihoodoftheseoutcomes.Asnotedabove,theseresultsdonotreflecttheeffectsofsomecriticalcomponentsoftheproposal,includingtheincentivesprovidedbytheproposaltoencouragebetterfunding.PlansponsorsmaychoosetomakeadditionalcontributionstoavoidbenefitrestrictionsortoavoidtheproposedhigherPBGCpremiums.Moregeneralbehavioralresponsestoeithereconomicconditionsortheproposalarealsonotincorporated.Thus,forexample,themodelingdoesnotincorporatethepossibilitythatcompaniesinasingleindustrywillseektoterminatetheirplansinresponsetotheterminationoftheircompetitors’plans.Theanalyticalmethodologyandassumptionsusedinthemodelingaredescribedmorefullyintheappendixtothispaper.AdditionalinformationaboutPIMSisinthe
Pension Insurance Data Book (1998)
,page10,availableonthePBGC’swebsiteat:http://www.pbgc.gov/publications/databook/databk98.pdf .
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