Defined Benefit Pension Reform for Single-Employer Plans

Order Code RL32991
CRS Report for Congress
Received through the CRS Web
Defined Benefit Pension Reform
for Single-Employer Plans
Updated January 26, 2006
Neela K. Ranade
Chief Actuary
Domestic Social Policy Division

Paul J. Graney
Analyst in Social Legislation
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress

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Defined Benefit Pension Reform
for Single-Employer Plans
Summary
The 109th Congress had considerable activity related to reforming the laws
governing the funding of single-employer defined benefit pension plans and the
premium structure for the Pension Benefit Guaranty Corporation (PBGC). Large and
growing deficits for the PBGC and continued underfunding of pension plans,
particularly for financially weak companies, are the major reasons behind the push
for reform.
This report outlines the complex current law governing the funding of single-
employer defined benefit pension plans. It discusses the role of the PBGC in insuring
pension benefits, the structure of the premiums that single-employer plans must pay
the PBGC, and the benefits guaranteed by the PBGC in exchange for the payment of
premiums. The report also describes reporting and disclosure requirements that
apply to plans.
The Administration, early in 2005, proposed comprehensive reform of pension
funding rules, PBGC premium structure, and reporting and disclosure requirements.
Under the proposed approach, the interest rates used for pension funding would be
based on a yield curve of corporate bond rates. This report describes the
Administration proposal and provides a simple example to illustrate calculation of
a liability using a yield curve.
The Administration proposal is the basis of the two major pension bills that
were introduced in the 109th Congress. These consist of H.R. 2830 (Pension
Protection Act of 2005) and S. 1783 (Pension Security and Transparency Act of
2005). In addition, budget reconciliation bills H.R. 4241 (Deficit Reduction Act of
2005) and S. 1932 (Deficit Omnibus Reconciliation Act of 2005) that were
introduced in the 109th Congress, include provisions to raise PBGC premiums paid
by employers.
This report includes quantitative analysis based on regulatory filings by pension
plans for 2001 and 2002 to provide an assessment of the number of plans that might
be affected by certain elements of the Administration proposal. It also summarizes
the reaction to the Administration proposal by business and labor.
The report also includes an illustration of the effect on a hypothetical plan
sponsor’s plan contribution and funded ratio of the credit balance approach used in
current law versus the Administration proposal.
The PBGC also insures multiemployer pension plans. The laws and issues
relating to multiemployer plans are quite different than for single-employer plans.
This report focuses on single-employer plans.
This report will not be updated.

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Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Current Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Pension Funding Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Role of the PBGC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Reporting and Disclosure Requirements . . . . . . . . . . . . . . . . . . . . . . . . 8
Administration Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Changing the Funding Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Improving the Financial Position of the PBGC . . . . . . . . . . . . . . . . . . 12
Improving Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Yield Curve Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Proposed Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Analysis of Form 5500 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Credit Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Use of Fair Market Value instead of Actuarial Value . . . . . . . . . . . . . 20
Reactions to Administration Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Appendix 1. Measures of Pension Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Appendix 2. Illustrative Impact of Alternate Credit Balance Proposals on
Minimum Required Contribution and Funded Ratio . . . . . . . . . . . . . . . . . . 25
List of Figures
Figure 1. Spot Yield Curve — Corporate AA Bonds 12/30/04, Percent . . . . . . 14
List of Tables
Table 1. Present Value Calculation Using Spot Yield Curve, Corporate
AA Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Table 2. Life Annuity Values Starting at Age 65 . . . . . . . . . . . . . . . . . . . . . . . . 16
Table 3. Prevalence of Positive Credit Balance for Single-Employer Plans . . . 18
Table 4. Prevalence of Positive Credit Balance for Underfunded
Single-Employer Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Table 5. Funding Interest Assumption for Single-Employer Pension Plans . . . . 20
Table 6. Ratio of Actuarial Value to Market Value for Single-Employer
Pension Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Table 7. Measures of Liability Under Pension Law . . . . . . . . . . . . . . . . . . . . . . 24
Table 8. Plan Characteristics for Illustration . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Table 9. Minimum Required Contributions Under Alternate Credit
Balance Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Table 10. Plan Assets and Funded Ratios Under Alternate Credit Balance
Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Winnie Sun, who worked as an actuarial intern in the Domestic Social Policy
Division in 2005, contributed analysis of Form 5500 Schedule B data.

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Defined Benefit Pension Reform for
Single-Employer Plans
Background
The Pension Benefit Guaranty Corporation (PBGC) is the federal agency that
insures most defined benefit pension plans. The PBGC posted a deficit (excess of
its liabilities over assets) of $22.8 billion as of September 30, 2005 for its single-
employer program.1 While the PBGC has sufficient assets to pay benefits for the
interim future, without changes in the law governing PBGC premiums and funding
of pension plans, it is estimated that the PBGC will run out of cash within the next
20 years.2 The PBGC deficit has created alarm and raised the specter of an eventual
taxpayer bailout of the PBGC.
Since the passage of the Omnibus Budget Reconciliation Act of 1987 (OBRA-
87) and until 2003, the interest rate used to calculate current liability that is used to
determine pension plan contributions was based on the rate on 30-year Treasury
bonds. When the Treasury stopped issuing 30-year Treasury bonds in September
2001, it was necessary to provide an alternative. The Pension Funding Equity Act
of 2004, P.L. 108-218, provided a temporary solution for years 2004 and 2005 by
requiring that the interest rate be based on the rate on high quality long-term
corporate bonds. This provision expired at the end of 2005. Unless pension reform
is passed in 2006 that extends the provisions of P.L. 108-218 with respect to the
current liability interest rate to the year 2006, the interest rate to be used by
employers for determining pension plan contributions will revert to that based on
long-term Treasury bonds.
In the 30 years since the passage of the Employee Retirement Income Security
Act (ERISA) in 1974, pension law has become increasingly complex with a
patchwork of legislation passed to meet the immediate and varying needs and
1 The PBGC’s assets consist of revenues from premiums charged on pension plans that it
insures, assets of terminated pension plans, and any asset recoveries from plan sponsors of
terminated pension plans. The PBGC assets also include investment income on PBGC
revenues. The PBGC’s liabilities consist of the present value of the benefits payable by the
PBGC for participants in terminated pension plans, plans whose termination is pending, and
probable terminations. The PBGC receives no appropriations from Congress. For
additional information on the PBGC’s financial status, see CRS Report RL32702, Can the
Pension Benefit Guaranty Corporation be Restored to Financial Health?, by Neela K
Ranade.
2 See page 5 of CBO testimony Defined-Benefit Pension Plans: Current Problems and
Future Challenges, before the Senate Finance Committee, June 7, 2005, at
[http://www.cbo.gov/ftpdocs/64xx/doc6414/06-07-PBGC.pdf].

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CRS-2
interests of different parties. In a departure from the incremental pension reform
approach used in the past, the Administration early in 2005 proposed fundamental
reform of pension funding rules, the PBGC premium structure, and reporting and
disclosure.
The Administration proposal is the basis of the two major pension bills that
were introduced in the 109th Congress. These consist of H.R. 2830 (Pension
Protection Act of 2005) and S. 1783 (Pension Security and Transparency Act of
2005). In addition, budget reconciliation bills H.R. 4241 (Deficit Reduction Act of
2005) and S. 1932 (Deficit Omnibus Reconciliation Act of 2005) that were
introduced in the 109th Congress, include provisions to raise PBGC premiums paid
by employers.
Current Law3
Overview. By law, plan sponsors generally must make annual contributions
to the pension plan so that plan assets are available to pay pension benefits promised
to employees. The defined benefit pension system is currently underfunded. The
PBGC estimates that total plan underfunding for single-employer plans on a
termination liability basis exceeded $450 billion as of September 30, 2005.4
Although plan sponsors are required to make contributions to pension plans, the law
provides so many exceptions and overrides that even a sponsor of a substantially
underfunded pension plan can go several years without making any contributions to
its pension plan.5 The interest rate used to determine the contribution to a pension
plan is another area of focus since the temporary provisions of the Pension Funding
Equity Act of 2004 expired at the end of 2005. An overview of funding rules for
single-employer defined benefit pension plans is provided below.
When underfunded pension plans terminate, the financial burden is placed on
the PBGC which had a deficit of $22.8 billion as of September 30, 2005 for its
single-employer program. The PBGC’s large deficit is the result of two factors;
substantial underfunding in plans that have terminated in the past, and inadequate
levels of premiums paid by plan sponsors to the PBGC. A description of premiums
payable to the PBGC, benefits guaranteed by the PBGC, and the PBGC’s (limited)
right to assets of sponsors of terminated plans is provided below.
3 For more details, see Joint Committee on Taxation, Present Law and Background Relating
to Employer-Sponsored Defined Benefit Pension Plans and the Pension Benefit Guaranty
Corporation (“PBGC”), JCX-03-05, Feb. 28, 2005; and Department of Labor, Strengthen
Funding for Single-Employer Pension Plans, Feb. 7, 2005.
4 Pension Benefit Guaranty Corporation Performance and Accountability Report-Fiscal
Year 2005, p. 13.
5 United Airlines and US Airways, for example, made no contributions for several years
preceding termination of their pilots’ pension plans, even though the plans were severely
underfunded. See PBGC testimony before the House Subcommittee on Transportation and
Infrastructure, June 22, 2005, available at [http://www.pbgc.gov/media/news-archive/
ExecutiveTestimony/tm13159.html].

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CRS-3
Under current law, pension plans are required to file information related to
funding and funded status with the Department of Labor (DOL), Internal Revenue
Service (IRS), and the PBGC. In addition, summary information must be provided
to plan participants. However, restrictions on disclosure of certain information may
result in participants being unaware of a plan being severely underfunded until it is
on the brink of termination. An overview of the reporting and disclosure
requirements under current law is provided below.
Pension Funding Rules. Under current law, the sponsor of a defined benefit
pension plan must make a contribution to the plan each year that is at least as large
as the minimum required contribution and no larger than the maximum deductible
contribution.6 The original rules relating to minimum required and maximum
deductible contributions were laid out by ERISA and were fairly straightforward.
These rules allowed the plan’s actuary to use one of several acceptable actuarial
funding methods7 and an interest rate based on his/her best estimate of anticipated
experience under the plan. The original calculations are now supplemented by
calculations based on a comparison between the plan’s assets and a more
standardized measure of the plan’s liability, known as the Current Liability.
The current liability is defined as the present value of plan benefits that have
accrued as of the valuation date determined with the use of standardized interest and
mortality assumptions specified by law. Several other technical terms are used in
pension funding law. The common ones are defined in the “Pension Funding
Terminology” box below.
There is less flexibility in the choice of the interest rate for determining current
liability than for determining the normal cost and accrued liability under the plan’s
funding method. Table 7 in Appendix 1 provides additional information on current
liability and accrued liability.
Historically, the interest rate used to determine current liability was based on the
rate on 30-year Treasury bonds. When the Treasury Department stopped issuing 30-
year bonds in September 2001, it allowed contributions to be determined based on
the rates on existing long-term Treasury bonds for plan years 2002 and 2003.8
However, with the ceasing of issuance of new 30-year Treasury bonds, the rates on
existing 30-year Treasury bonds dropped. Use of a lower interest rate leads to higher
pension contributions. The business community would likely have found continued
use of a required interest rate based on rates on existing Treasury bonds unfair. It
6 A plan sponsor may make a contribution in excess of the maximum deductible limit.
However, this would be subject to an excise tax.
7 The actuarial funding methods listed on the 2005 Schedule B of the Form 5500 are attained
age normal, entry age normal, accrued benefit, aggregate, frozen initial liability, individual
level premium, and the individual aggregate method.
8 For the 2001 and prior plan years, the interest rate used to determine the current liability
was required to fall between 90%-105% of the four-year weighted average of rates on long-
term Treasury bonds. Under the terms of the Job Creation and Worker Assistance Act of
2002 (P.L. 107-147), the permissible range was changed to 90%-120% of such weighted
average for plan years 2002 and 2003.

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CRS-4
was necessary to find a different solution for the current liability interest rate. The
Pension Funding Equity Act (P.L. 108-218) came up with a solution, but only for two
years. It specified that for plan years 2004 and 2005, the interest rate for determining
the current liability must fall within 90%-100% of the four-year weighted average of
rates on long-term corporate bonds.
Pension Funding Terminology
Actuarial funding method — An orderly method of developing the costs of a pension plan such
that the payment of these costs will accumulate to the reserve required at retirement age. A plan’s
funding method determines the normal cost and accrued liability for the plan based on the
demographics of plan participants and actuarial assumptions.
Actuarial assumptions — Assumptions that are required to determine the funding calculations.
Primary among these are the interest rate assumption for the return expected to be earned by plan
assets and the mortality assumption for the plan participants.
Actuarial present value — The value of future benefit payments discounted with interest to the
current time to take into account the time value of money and adjusted to reflect the probability of
payment by use of decrements for death, turnover, retirement and disability.
Normal cost — The portion of the actuarial present value of total pension benefits that is
attributable to the current year’s service under the actuarial funding method chosen for the plan.
Accrued liability — The portion of the actuarial present value of total pension benefits that is
associated with the past under the actuarial funding method.
Actuarial Value of plan assets (AV) — Takes into account the fair market value of plan assets
(MV) and may smooth fluctuations in MV by gradually recognizing appreciation or depreciation
of plan assets over no more than five years. Under current law, the AV must be between 80% and
120% of the MV. The AV is used in the determination of the minimum required and maximum
deductible funding limits.
Funding Standard Account (FSA) — An accounting device included in Schedule B of the Form
5500 that the plan sponsor must file each year. It is used to monitor compliance with the minimum
funding rules. Charges to the FSA consist of the normal cost and amortization of unfunded
liabilities. Plan contributions are credited to the FSA.
Credit balance — The balance created in the Funding Standard Account when the plan sponsor
makes a contribution in excess of the minimum required contribution. It is carried over with
interest at the rate assumed in the plan’s funding calculations and may be used to reduce the
employer’s plan contribution for the following year.
A term used in the definitions of the minimum required and maximum
deductible contributions is the Full Funding Limitation. The full funding limitation
(FFL) is the excess, if any, of (1) the accrued liability under the plan (including
normal cost); over (2) the lesser of (a) the market value of plan assets or (b) the
actuarial value of plan assets. However, the full funding limitation may not be less
than the excess, if any, of 90% of the plan’s current liability (including the current
liability normal cost) over the actuarial value of plan assets.9
9 For plan years 2002 and 2003,the FFL was the excess if any of the lesser of (1)(a) accrued
liability under the plan including normal cost or (b) the applicable percentage of the current
liability (including current liability normal cost), over the lesser of (2)(c) market value of
(continued...)

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CRS-5
Minimum Funding Rules. The minimum required contribution is generally
equal to the sum of the normal cost and the amortized amount of the unfunded
accrued liability (accrued liability less actuarial value of plan assets), reduced by the
Funding Standard Account (FSA) credit balance. The FSA is used to track
contributions made by a plan sponsor in excess of the minimum required
contribution. Appendix 2 provides a numerical example of a FSA under current law
and under possible alternative definitions.
Interest is accrued on charges and credits in the FSA at the rate assumed for
determining the plan contribution under the plan’s funding method. This rate is
chosen by the plan’s actuary so that together with other assumptions such as
mortality, employee turnover, etc., it represents his best estimate of anticipated
experience under the plan.
Additional funding requirements apply to certain underfunded plans. Under
special funding rules, called the “deficit reduction contribution” rules, a plan with
over 100 participants may be required to make additional funding contributions under
certain conditions.10 The additional funding contribution requirements generally
apply when the actuarial value of the plan’s assets is less than 90% of the current
liability.11
Calculation of the additional contribution under the deficit reduction
contribution rules is complex and involves a faster amortization of the plan’s
unfunded liability for a plan that has a low ratio of current liability to the actuarial
value of plan assets.12 The law contains an override provision that specifies that the
amount of the additional required contribution may not exceed the amount needed
to bring the plan’s actuarial value of plan assets to the level of its current liability.
Regardless of whether the deficit reduction contribution rules apply, no
contributions are required under the minimum funding rules in excess of the Full
Funding Limitation.
Under the Pension Funding Equity Act of 2004, commercial airlines, steel
manufacturers, and certain other employers were allowed to use special rules to
9 (...continued)
plan assets or (d) actuarial value of plan assets. The applicable percentage was defined as
165% for 2002 and 170% for 2003. However, the FFL could not be lower than the excess
if any of 90% of the current liability (including current liability normal cost) over the
actuarial value of plan assets.
10 The additional funding requirements were enacted by OBRA-87 and amended by the
Retirement Protection Act of 1994 to address demands on the PBGC insurance system as
a result of terminations of underfunded pension plans.
11 However, the requirement does not apply if the actuarial value of the plan’s assets is
between 80% and 90% of current liability, provided that the plan’s assets were at least 90%
of current liability in two consecutive years out of the last three years.
12 For a more complete description of additional funding requirements, see Present Law and
Background Relating to Employer-Sponsored Defined Benefit Pension Plans and the
Pension Benefit Guaranty Corporation (“PBGC”), JCX-03-05, Feb. 28, 2005.

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CRS-6
reduce significantly the deficit reduction contribution for plan years beginning
between December 28, 2003 and December 27, 2005.13
Maximum Deductible Contributions. The maximum deductible
contribution determined under the plan’s funding method is generally equal to the
normal cost plus a 10-year amortization of any unfunded accrued liability. However,
the maximum deductible contribution may not be greater than the full funding
limitation. Under a special rule, a plan sponsor may deduct amounts contributed to
the plan that are not in excess of the amount necessary to bring the plan’s assets up
to the current liability, without regard to whether the plan assets exceed the accrued
liability under the plan’s funding method.
Impact of Funding Rules on Funded Status. Three elements of the
funding rules have contributed to the underfunding of pension plans in recent years
and changes in these have been incorporated in many legislative proposals for
funding reform:
! The definition of the Full Funding Limitation is based on 90% of the
current liability, not 100% of the current liability. Also, the
threshold for triggering of additional contributions under the deficit
reduction contribution rules is based on 90% of current liability
rather than 100% of current liability.
! The asset measure used in the definitions of the unfunded accrued
liability under the plan’s funding method, the Full Funding
Limitation, and the threshold for triggering of additional
contributions under the deficit reduction contribution rules is based
on the actuarial value of plan assets. In years of market decline, the
actuarial value can be higher than the market value due to the
deferral of recognition of capital losses. For such years, the required
contributions for plans that choose to spread capital losses (and
gains) can be significantly lower than if the market value of assets
was used.
! The credit balance in the Funding Standard Account is credited with
interest at the assumed interest rate and may be used to lower the
required funding contribution even when plan assets have suffered
major losses and fallen below plan liabilities.
While the above elements of current funding rules may be appropriate for
ongoing healthy plans, they can substantially contribute to the existing underfunding
of plans of financially weak companies that are close to termination.
Role of the PBGC. The PBGC was established under ERISA to provide
mandatory pension insurance for defined benefit pension plans. The premiums that
companies pay for this insurance help to finance the benefits that PBGC distributes
to beneficiaries of underfunded terminated plans. The assets taken over from those
13 For more information, see CRS Report RS21717, H.R. 3108: The Pension Funding
Equity Act, by Patrick Purcell and Paul Graney.

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CRS-7
plans, investment earnings, and any recoveries from sponsors of terminated plans are
the other sources of these benefit payments.
PBGC Premiums. The single-employer program has two different premium
rates. The annual flat-rate premium that every sponsor pays was raised by Congress
to $19 per participant in 1991 and has remained unchanged since then. The variable-
rate premium is charged to certain underfunded plans. It was last modified in 1994
and is currently $9 per $1,000 of the plan’s unfunded vested benefits. The plan’s
unfunded vested benefits are defined as the excess of the plan’s current liability,
taking into account only vested benefits, over the actuarial value of the plan’s
assets.14 However, a plan with unfunded vested benefits is nevertheless exempt from
paying variable-rate premiums if the plan was at full funding limit for the prior plan
year (i.e., the sponsor had made a plan contribution for the prior plan year not less
than the Full Funding Limitation for the prior plan year under Section 412(c)(7) of
the Internal Revenue Code (IRC)).
The interest rate used to determine vested benefits for purposes of calculation
of the variable premium differs from the rate used for funding purposes. For plan
years 2001 and before, it was 85% of the rate on 30-year Treasury bonds. P.L. 107-
47 changed it to 100% of the rate on 30-year Treasury bonds for plan years 2002 and
2003. P.L. 108-218 further modified it to 85% of the rate on long-term corporate
bonds for plan years 2004 and 2005. As of December 31, 2005, the rate reverted to
the rate based on long-term Treasury bonds. If proposed pension legislation (H.R.
2830, S. 1783) is enacted, it would extend the applicability of P.L. 108-218 with
respect to the interest rate used for variable-rate premium purposes to plan year 2006.
Table 7 in Appendix 1 provides additional information on the determination of the
present value of vested benefits for purposes of determination of the variable-rate
premium.
Guaranteed Benefits. Under ERISA, no further service credit is earned
toward accruing benefits, vesting, and entitlement to retirement subsidies once a plan
is terminated. As of that date, the plan administrator allocates the plan assets among
six priority categories as the statute dictates. If there are not enough assets to pay all
the benefits that have accrued, the PBGC takes over the plan as trustee and pays the
plan participants guaranteed benefits. Only basic benefits are guaranteed and benefits
from new plans and recent amendments are phased in at the rate of 20% per year for
five years.15 Non-vested pension benefits are not guaranteed.
The maximum PBGC guarantee per covered participant is $3,971.58 per month
at age 65 for plans terminating in 2006, and is reduced for benefits commencing prior
to age 65. This provision has caused considerable distress to retired pilots of airline
14 IRC Section 412(l)(7)(C)(ii)(II) allows the Secretary of the Treasury to specify an updated
mortality table to be used by pension plans for the determination of the current liability and
the vested benefits. 29 CFR§4006.4 states that when the mortality table is updated, the fair
market value of assets rather than the actuarial value of assets must be used to determine the
unfunded vested benefits.
15 This phase-in period is 30 years beginning with participation in the plan for a substantial
owner, i.e., one who owns more than 10% of the company.

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pension plans terminating with insufficient assets. Under federal regulation, airline
pilots are forced to retire at age 60.16 The maximum PBGC guaranteed benefit for
a pilot who retired at age 60 and whose pension plan terminated in 2005 would be
$2,851.53 ($3,971.58 times 0.65), considerably lower than the typical pension benefit
for a full service airline pilot that might amount to $10,000 per month.
Contingent benefits such as those that have been promised in a case where a
plant shuts down are only guaranteed if the precipitating event takes place before the
termination date. This is why PBGC will try to terminate a plan before a company
triggers shutdown benefits by closing its plants. Since contingent benefits cannot be
prefunded, they can place a great strain on PBGC’s resources.
Lien Against Plan Sponsor Assets. When a plan sponsor does not make
required contributions to the plan, it weakens the plan’s funded status and increases
the potential claim against the PBGC. Both ERISA and the IRC give the PBGC the
right to perfect a lien against the assets of a plan sponsor and members of its
controlled group when $1 million in required pension contributions are missed, but
only if they have not filed for bankruptcy. The Bankruptcy Code currently keeps the
PBGC from perfecting a lien against the debtor, and effectively prevents it from
requiring further contributions to the plan.
PBGC’s Right to Recovery for Unfunded Benefits. The law allows the
PBGC to attempt to recover monies for unfunded pension liabilities from other assets
of the plan sponsor. When the PBGC does make recoveries on its claims for
unfunded benefit liabilities, it shares the proceeds with beneficiaries who are not
receiving the full benefits to which they were entitled under the plan. In the event
that sufficient monies are recovered, a plan participant’s benefit could be higher than
the maximum PBGC guaranteed benefit. ERISA prescribes the use of an average
recovery ratio over the five years immediately preceding the year in which the plan
terminates instead of using the actual amount recovered for each individual plan. For
very large plans with over $20 million in participants’ benefits losses, the actual
amount of the recovery is used to determine how much will be allocated to the
participants. Any amounts recovered from the plan sponsor for contributions that
were due before termination are considered as plan assets as of the termination date
and are distributed in the same manner as the rest of the assets available at that time.
All amounts are determined according to the actual amount recovered for the specific
plan regardless of the size of the recovery.
Reporting and Disclosure Requirements. Both ERISA and the IRC
require defined benefit plans to provide annual information related to funding and the
funded status of the plan to the IRS, DOL, and PBGC. Certain reports and notices
must also be provided to participants and beneficiaries on an annual basis. There are
additional reporting requirements for underfunded pension plans.
Form 5500. A qualified pension plan generally must submit an annual report
(Form 5500) with information pertaining to the qualification, financial condition, and
16 For additional information, see CRS Report RL32960, Age Restrictions for Airline Pilots:
Revisiting the FAA’s ‘Age 60 Rule’, by Bart Elias.

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CRS-9
operation of the plan. Form 5500 must be filed with the DOL seven months after the
end of the plan year unless the available 2½-month extension has been granted. A
defined benefit plan subject to minimum funding standards of ERISA generally must
include an actuarial statement on Schedule B that is certified by an actuary enrolled
to practice before the IRS, DOL, and PBGC. The Schedule B includes information
on the plan’s assets, accrued and current liabilities, contributions from the sponsor,
expected payments to beneficiaries, actuarial cost method and actuarial assumptions,
and amortization bases established during the plan year. The Schedule B also
includes the Funding Standard Account statement for the plan year. The DOL
forwards a copy of the Form 5500 including the Schedule B to the IRS and the
PBGC.
Summary Annual Report. The plan administrator must send a summary of
the annual report (SAR) to participants and beneficiaries with basic financial
information about the plan. The SAR must state whether the contributions to the
plan were enough to meet the minimum funding standards and the amount of any
deficit. In the case where the plan’s assets are valued at less than 70% of the current
liability under the plan, the SAR must state the percentage of such current value of
the plan’s assets. The SAR must be provided within nine months after the end of the
plan year or within two months after the extended due date for the Form 5500, if
applicable. In addition, upon written request, a plan participant must be provided
with a copy of the full annual report (Form 5500).
Participant Notice of Underfunding. Under ERISA Section 4011, plan
administrators of certain underfunded plans must notify participants and beneficiaries
annually of the plan’s funding status and the limits of the PBGC’s guarantee. A
Participant Notice is due two months after the due date (including extensions) for the
Form 5500. The plan administrator of any single-employer plan for which a variable
rate premium (VRP) is payable for the plan year is required to issue a Participant
Notice, unless the plan meets the Deficit Reduction Contribution (DRC) Exception
Test for the plan year or the prior plan year. A plan meets the DRC Exception Test
for a plan year if the actuarial value of plan assets is at least 90% of the current
liability. A plan with actuarial value of plan assets between 80% and 90% of current
liability will still meet the DRC Exception Test if the actuarial value of plan assets
was at least 90% of current liability in two consecutive years out of the last three
years.
Section 4010 Disclosure. Section 4010 of ERISA requires the reporting of
plan actuarial and company financial information by employers with plans that have
(I) aggregate unfunded vested benefits in excess of $50 million (determined on a
variable-rate premium basis)17, (ii) missed required contributions in excess of $1
million, or (iii) outstanding minimum funding waivers in excess of $1 million. Filing
17 Under pending legislation, for purposes of the 4010 Gateway test, employers would use
the Pension Funding Equity Act 85% corporate rate for 2006 instead of the snap-back 85%
Treasury rate. Because this creates uncertainty as to which interest rate would be applicable,
the PBGC in Technical Update 06-1, announced that it would waive Section 4010 reporting
in 2006 for certain employers.

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CRS-10
is on a controlled group basis.18 The information is required to be filed with the
PBGC and includes the plan’s fair market value of assets and its termination liability.
Table 7 of Appendix 1 provides additional information on determination of the
termination liability for Section 4010 disclosure purposes. Plan sponsors must
provide Section 4010 information within 105 days after the end of their “information
year.” This is April 15 for most employers.
Section 4010(c) prohibits the PBGC from disclosing §4010 information, except
for information that is otherwise public. As a result, plan participants of severely
underfunded pension plans of financially troubled companies may be unaware of the
extent of the problem until the company is in bankruptcy reorganization and the plan
is about to be taken over by the PBGC.
Administration Proposal19
The Administration has proposed a comprehensive overhaul of the laws
governing the defined benefit pension system. The proposal included in the FY2006
budget submission consists of a three-pronged approach to reform: changing the
rules for funding defined benefit plans, improving the financial position of the
PBGC, and improving disclosure to better inform workers, investors, and regulators.
Changing the Funding Rules. In place of the various measures of pension
liabilities described above, the Administration has proposed the adoption of a single
measure of liabilities based on benefits earned to date with minimal smoothing. The
proposal would also adjust the funding target of a plan according to the financial
strength of the plan sponsor. The time allowed to make up shortfalls would be
shortened, and limitations would be placed on benefit enhancements and accelerated
distributions during periods of severe underfunding. The final change in funding
rules would allow plans to make additional deductible contributions during periods
of favorable economic conditions.
Measuring Assets and Liabilities. The Administration’s position is that
the smoothing available under current law masks the underlying financial weakness
of many underfunded pension plans. Its proposal would measure assets at fair market
value on the valuation date for the plan (the first day of the plan year for plans with
more than 100 participants, or any day of the plan year for smaller plans). For a
healthy plan sponsor, the funding target would be based on its ongoing liability. The
ongoing liability like the current liability is defined as the present value of benefits
earned to date. However, the discount rate used to calculate the plan’s ongoing
18 Two or more companies are said to form a controlled group if the parent corporation owns
at least 80% of the stock in each company.
19 For more details, see Joint Committee on Taxation, Present Law and Background
Relating to Employer-Sponsored Defined Benefit Pension Plans and the Pension Benefit
Guaranty Corporation (“PBGC”), JCX-03-05, Feb. 28, 2005; Department of Labor,
Strengthen Funding for Single-Employer Pension Plans, Feb. 7, 2005; Department of Labor,
Fact Sheet: The Bush Administration’s Plan for Strengthening Retirement Security; and
Assistant Secretary of Treasury Mark J. Warshawsky’s testimony before the Senate Special
Committee on Aging, Apr. 12, 2005.

---

CRS-11
liability as of the valuation date would be based on a spot yield curve of high quality
corporate bonds. This concept is explained below in the ‘Yield Curve Proposal’
section. There would be a three-year phase-in period. Projections of future salary
increases would not be used in determining the present value of expected benefit
payments, but plans would be required to include the likelihood of lump sum
payments in calculating their liabilities. The spot yield curve would eventually be
used in determining lump sum payments, but this would have a longer phase-in
period than its use in determining liabilities and funding requirements.
The proposal would also include additional costs in determining what it calls the
at-risk liability of a plan that is financially weak. While plans with ongoing liability
would rely on relevant recent historical experience in setting assumptions for age at
retirement and lump sum elections, at-risk plans would be required to assume that
participants would retire at the earliest opportunity and take a lump sum or another
form of distribution that results in the largest liability for the plan. A loading factor
that reflects the administrative costs of terminating the plan would also be included
in at-risk liability.
Funding Targets. The proposal would link a plan’s funding target to the
financial health of the plan sponsor. The minimum required contributions of a firm
with debt that is rated as investment grade would be enough to fund its ongoing
liability including the normal cost for the current plan year. A financially weak firm
would be responsible for funding its at-risk liability including a loading factor of
$700 per participant plus 4% of the at-risk liability. Presuming that the at-risk
liability would be significantly higher than the ongoing liability, the proposal
provides for a phase-in period of five years during which the actual funding target for
financially weak firms would be a weighted average of the ongoing and at-risk
targets.
Time Allowed to Make Up Shortfalls. A seven-year amortization period
would be established for funding any shortfalls (amounts by which the asset value of
a plan is below its funding target on the valuation date). The plan sponsor would be
required to amortize the shortfall in level amounts over the next seven years. On the
valuation date in the following year, the present value of the amortization payments
due in the next six years would be added to the value of the plan’s assets and that
total would be compared to the plan’s funding target. If a shortfall results, that
would similarly be amortized in seven level payments. If there is no new shortfall,
the plan would continue to pay the same amounts of remaining amortization
payments as in the preceding year. This process would continue in each subsequent
year.
For each year, a plan’s sponsor would be required to contribute enough to cover
that year’s normal cost plus any amortization payments that are due to fund shortfalls.
A plan sponsor could contribute more than the minimum required contribution, but
merely that fact would not reduce the required payments for amortization of funding
shortfalls. However, amortization payments would cease once the market value of
plan assets exceeded the funding target. If the market value of plan assets exceeded
the funding target by more than the normal cost, no plan contribution would be
required for the year. The proposal would require a plan to make quarterly payments
if its funding target was not fully covered by the value of its assets in the previous

---

CRS-12
year. Fully funded plans would continue to have 8½ months after the end of the plan
year to make their minimum required contributions.
Credit Balance. Under current law, a plan with a large credit balance may
have no minimum required contribution even if the value of plan assets has dropped
below the value of plan liabilities. A typical pension plan invested 60% in large cap
common stocks and 40% in corporate bonds earned an investment return of -3.75%
in 2001 and -9.16% in 2002.20 This led to the market value of assets for many
pension plans dropping below the value of plan liabilities. Nonetheless, if such a
pension plan had a high enough credit balance in its Funding Standard Account at the
beginning of the year, the plan sponsor was not required to make any pension
contribution. The Administration’s proposal would eliminate the credit balance so
that it can no longer be used to offset the minimum required contribution.
Limiting Benefits and Distributions. In addition to keeping the present
prohibition on a company in bankruptcy increasing its benefits, the proposal would
freeze benefits and prevent additional accruals if the company’s plan is not fully
funded. The prohibition on benefit increases would also apply to any plan that was
not funded at more than 80% of its target unless additional contributions were made
to cover the cost of the amendment. In addition, continued accruals would be frozen
for the plans of financially weak sponsors that were not funded at more than 60% of
their target. These sponsors would also face restrictions against funding nonqualified
deferred compensation arrangements for their top executives. These limits on benefit
increases and accruals would not affect a plan in its first five years.
The prohibition on distributions in forms other than an annuity (e.g., lump sums)
that applies to plans during a period of a liquidity shortfall would be extended under
the proposal to all plans of companies in bankruptcy that are less than 100% funded,
all plans that are funded at 60% or less, and to financially weak plans that are funded
at 80% or less, based on the plan’s funding target.
Increasing Deductible Contributions. The Administration’s proposal
would allow companies to increase the amount of their deductible contributions by
including two separate cushion amounts in their calculations. In addition to the
amounts needed to raise the value of the plan assets to the sum of its funding target
and that year’s normal cost, plan sponsors could deduct contributions up to 30% of
the plan’s funding target and any increases that may be expected for future salary
increases in a final salary plan or for benefit increases in a flat dollar plan. Finally,
the deductible limit for the year would not be less than the sum of the plan’s at-risk
liability and its at-risk normal cost, regardless of whether the company is financially
weak or not. The Full Funding Limitation would be eliminated.
Improving the Financial Position of the PBGC. The proposal would
adjust the annual flat-rate premium for all plans from $19 to $30 per participant.
This adjustment is based on the increase in the Social Security Administration’s
Average Wage Index since the $19 rate was set in 1991. This index is used to
20 Common stocks assumed to track the S&P 500 stock index and corporate bonds assumed
to track the Lehman Brothers Aggregate Bond Index.

---

CRS-13
determine the annual increase in PBGC’s maximum benefit guarantee and would be
used to adjust the premium each year as well. The variable-rate premium of current
law would be replaced by a risk-based premium that would be paid by any plan with
assets less than its funding target. The same rate per dollar of underfunding would
be paid by all plans. Plans with financially weak sponsors would be charged for each
dollar of unfunded at-risk liability while plans with financially healthy sponsors
would be charged for each dollar of unfunded ongoing liability. Note that the
premium would be based on every dollar of unfunded liability (whether the benefits
are vested or unvested) versus every dollar of unfunded vested benefits under current
law. The rate for the risk-based premiums would be set periodically by the PBGC
Board based on the goals of meeting expected future claims and eliminating the
PBGC’s current deficit over a reasonable period of time.
The proposal would also freeze the PBGC guaranty when a plan sponsor enters
bankruptcy proceedings. If a plan terminates during these proceedings or within two
years after the company emerges from bankruptcy, the PBGC guaranteed benefits
would be based on plan provisions, salary and service records, and guaranty limits
that were in effect on the date that the company entered bankruptcy. The plan
administrator would be required to notify participants of these limitations put into
effect by the bankruptcy. The proposal would amend federal bankruptcy laws to
create an exemption that would allow the creation and perfection of a lien in favor
of the PBGC against the plan sponsor for missed pension contributions, regardless
of whether the lien is perfected before the company enters bankruptcy proceedings.
The PBGC guaranty provisions would be amended to eliminate any coverage for
unpredictable contingent event benefits, such as plant shutdown benefits.
Improving Disclosures. The proposal would require additional disclosures
on a plan’s Summary Annual Reports to participants (SAR) and to the government
(Form 5500). On the Form 5500, plans would be required to disclose both ongoing
and at-risk liability whether or not the sponsor was financially weak. The Schedule
B actuarial statement would show the market value of the plan’s assets in addition
to the ongoing and at-risk liability. The SAR would show the funding status of the
plan for each of the three last years as a percentage based on the ratio of the plan’s
assets to the appropriate funding target. The SAR would also include information on
the financial health of the company and on the PBGC. The participant notice of
underfunding required by §4011 of ERISA would be replaced by the SAR, which
would now be due 15 days after the filing date for the Form 5500 and would be
required to be sent to all participants regardless of the plan’s funding status.
For plans that cover more than 100 participants and are required to make
quarterly contributions because of their underfunding, the deadline for the Schedule
B actuarial report would be moved up to the fifteenth day of the second month after
the close of the plan year. Any additional contribution made for the plan year would
be included on an amended Schedule B filed with the Form 5500.
Information filed with the PBGC pursuant to §4010 of ERISA would generally
be available to the public. Confidential “trade secrets and commercial or financial
information” would continue to fall under the Freedom of Information Act
protections for corporate financial information.

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CRS-14
Yield Curve Proposal
Under current practice for the determination of present values, liabilities, and
normal cost for a pension plan, a single interest rate is used to discount pension
amounts payable at different points in the future. Under the Administration proposal,
the ongoing liability, at-risk liability, and normal cost would be determined using a
series of interest rates drawn from a yield curve for corporate bonds based on the
timing of pension payments. This corporate bond yield curve would be issued
monthly by the Secretary of the Treasury and would be based on the interest rates
(averaged over 90 business days) for high quality corporate bonds (i.e., bonds rated
AA) with varying maturities. Figure 1 illustrates a yield curve.
Figure 1. Spot Yield Curve — Corporate AA Bonds 12/30/04,
Percent
Source: Department of the Treasury, Creating a Corporate Bond Spot Yield Curve for Pension
Discounting, from website [http://www.treas.gov/offices/economic-policy/reports/pension_yield
curve_020705.pdf].
Provided below is a simple example to illustrate the use of a yield curve for
discounting. Consider a pension plan that covers four employees currently aged 25,
35, 45, and 55 which expects to make lump sum payments of $1,600,000, $800,000,
$400,000, and $200,000 to these employees respectively when each reaches the
retirement age of 65. Table 1 shows the calculation of the present value of lump sum
payments using spot rates from the yield curve in Figure 1. The total present value
of lump sum payments using spot rates is $503,484.60.

---

CRS-15
Under prevalent actuarial practice, a single interest rate is used to discount
future benefits. If a single rate of 6% was used to discount the same lump sum
payments, the present value would be $531,244.50.21
Table 1. Present Value Calculation Using Spot Yield Curve,
Corporate AA Bonds
(d) =
(c)*(1/(1+(b)^(a))
(c) Lump sum
Present value of
Employee
(a) Years to
(b) Spot
payment at age
lump sum
current age
retirement
rate
65
payment
55
10
5.02%
$200,000
$122,549.0
45
20
5.96%
$400,000
$125,666.9
35
30
6.33%
$800,000
$126,886.5
25
40
6.51%
$1,600,000
$128,382.1
Total
$503,484.60
Source: Department of the Treasury, Spot rates from Appendix 2 of Creating a Corporate Bond Spot
Yield Curve for Pension Discounting, [http://www.treas.gov/offices/economic-policy/reports/
pension_yieldcurve_020705.pdf]. Calculations by the Congressional Research Service (CRS).
Note: December 30, 2004 average of 90 business days.
The typical pension plan pays benefits as a stream of payments starting at
retirement age, so that determining the present value of benefits using a yield curve
is more complicated. However, large pension plans use sophisticated computer
models to perform pension valuations and modification of these models to
accommodate the yield curve should not be difficult.
Table 2 shows the values of life annuities payable at age 65 for different
current ages using a single corporate bond rate versus a yield curve based on
corporate bonds. The RP-2000 mortality table with 50% males and 50% females is
used. In column (1) of Table 2, a single long-term corporate interest rate is used
equal to the average yield on the Merrill Lynch U.S. Corporate Bond Index with AA
ratings and time to maturity longer than 15 years. The average redemption yield on
this index was 5.737% as of March 3, 2004, the date as of which the life annuity
values in Table 2 were determined. Column (2) uses a corporate bond yield curve
computed using AA-rated financial bonds.
As Table 2 illustrates, the present value of a life annuity starting at age 65 is
higher for individuals aged 65 and 60 when a corporate bond yield curve is used
instead of a single corporate bond rate. However, for individuals aged 50, 40, or 30,
2 1 1 , 6 0 0,000*(1/1.06)^40+800,000*(1/1.06)^30+4 0 0 , 0 0 0 * ( 1 / 1 . 0 6 ) ^ 2 0 +
200,000*(1/1.06)^10.

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CRS-16
the use of a corporate bond yield curve for discounting instead of a single corporate
bond rate reduces the value of the annuity.
The mechanism used to construct the corporate bond yield curve for the
example in Table 2 is somewhat different than the one proposed by Treasury.
However, the message of Table 2 applies just as much to the Treasury proposal. Use
of a yield curve for discounting instead of a single interest rate, will generally
increase the pension liabilities for older employees while it will reduce them for
younger employees. The one exception is for situations when the yield curve is
inverted (i.e., spot interest rates for longer durations are lower than spot interest rates
for shorter durations).
Table 2. Life Annuity Values Starting at Age 65
(1) Single corp.
(2) Corp. bond
Age
Change (2)-(1)
bond rate
yield curve
65
11.22
11.73
4.55%
60
8.10
8.25
1.85%
50
4.42
3.89
-11.99%
40
2.46
1.94
-21.14%
30
1.38
1.01
-26.81%
Source: The Pension Forum, Understanding the Corporate Bond Yield Curve, by Höfling, Kiesel,
and Löffler, Dec. 2004.
As a result, use of the yield curve will generally raise the contribution for a plan
consisting of older participants as compared to an approach under which a single
interest rate is used. Manufacturing companies such as the auto makers and auto
suppliers tend to be comprised of older employees and will generally be required to
make higher contributions under the yield curve proposal.
Proposed Legislation
Major pension bills, seeking to reform the defined benefit pension system, were
passed by the House and Senate in the first session of the 109th Congress and are
headed to conference, probably by spring of 2006. These bills aim at strengthening
the funding of defined benefit pension plans and improving the solvency of the
PBGC. The bills include provisions to raise PBGC premiums and would tighten
funding rules, resulting in higher pension funding requirements for many employers.
H.R. 2830, the Pension Protection Act of 2005, was passed by the House on
December 15, 2005.22 S. 1783, the Pension Security and Transparency Act of 2005,
22 For additional information, see CRS Report RS22179, H.R. 2830: The Pension Protection
Act of 2005, by Patrick Purcell.

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CRS-17
was passed by the Senate on November 16, 2005.23 It is expected that the House and
Senate will try to reach conference agreement on the bills by April 15, 2006, when
employer quarterly plan contributions are due. Failure to do so could result in a
reversion to the lower 30-year Treasury rate for funding pension plans and restitution
of deficit reduction contributions (DRCs). The Pension Funding Equity Act (H.R.
3108), passed in 2004, replaced the 30-year Treasury bond rate with a higher
composite corporate bond rate as the benchmark for defined benefit plan funding
calculations. The act also allowed companies in certain industries to postpone DRCs.
These provisions expired on December 31, 2005.24 It is expected that a pension
reform bill, if passed, will extend the provisions of the Pension Funding Equity Act
with respect to the current liability interest rate until December 31, 2006, thereby
relieving employers from high funding requirements resulting from the use of the 30-
year Treasury rate.
In addition, increases in PBGC premiums are an important element of the
budget reconciliation packages, H.R. 4241 and S. 1932, passed by the House and
Senate in the first session of the 109th Congress. These included differing provisions
for increasing PBGC premiums. A conference report on the two bills reconciling the
different House and Senate versions was approved by the Senate on December 21,
2005, but has yet to pass the House. The House is expected to vote on the conference
report in February 2006. The pension provisions of the conference agreement as
passed by the Senate are estimated to save $417 million in 2006 and $3.56 billion
over 2006 - 2010.25
Analysis of Form 5500 Data
An exhaustive analysis of the impact of reform proposals is beyond the scope
of this report. However, this section assesses the number of plans that might be
affected by provisions of the Administration proposal related to the credit balance in
the Funding Standard Account and the actuarial value of plan assets. Form 5500
Schedule B filings for 2001 and 2002 for plans covered by the PBGC were used to
conduct the analysis. PBGC provided data for the analysis. The analysis indicated
29,315 plans for 2001 and 28,265 plans for 2002.26 The PBGC and the Government
Accountability Office (GAO) have conducted other analyses using larger plans.27
23 For additional information, see CRS Report RS22221, S. 1783: The Pension Security and
Transparency Act of 2005, by Patrick Purcell.
24 For additional information, see CRS Report RS21717, H.R. 3108: The Pension Funding
Equity Act, by Patrick Purcell and Paul Graney.
25 For additional information, see CRS Report RS22315, Budget Reconciliation and the
PBGC, by Neela K. Ranade.
26 Table S-31 of PBGC’s Pension Insurance Data Book 2004 shows the number of single-
employer plans covered by the PBGC to be 32,954 for 2001 and 31,229 for 2002. However,
not all of these are required to file Schedule B forms.
27 Analysis of the 100 largest single-employer defined benefit pension plans is available in
the transcript of GAO’s testimony before the Committee on the Budget, House of
Representatives, Private Pensions: The Pension Benefit Guaranty Corporation and Long-
(continued...)

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CRS-18
Credit Balance. Under the Administration proposal, use of the credit balance
to reduce the minimum required contribution would be prohibited for all plans. The
Congressional Research Service (CRS) analyzed Form 5500 Schedule B data for
2001 and 2002 to evaluate the prevalence of positive credit balances for pension
plans and the extent to which positive credit balances contributed to the plan sponsor
making no contributions to the plan. CRS conducted the analysis for all plans and
separately for underfunded plans.
Table 3. Prevalence of Positive Credit Balance for
Single-Employer Plans
Number of Plans
Category of Plans
2001
2002
All
29,315
28,265
Positive credit balance at beginning of year (BOY)
18,175 (62%)
17,455 (62%)
No employer contribution for year
8,988 (31%)
6,689 (24%)
No employer contribution for year and positive
5,998
4,274
credit balance at BOY
Source: The Congressional Research Service (CRS) analysis of Form 5500 Schedule B data.
Note: Only plans covered by the PBGC and that had filed the Schedule B were considered.
As Table 3 illustrates, for 2001 as well as 2002, a substantial proportion (62%)
of single-employer pension plans had a positive credit balance at the beginning of the
plan year.28 The proportion of plans with no employer contribution was 31% in 2001
and dropped somewhat to 24% in 2002. Of the plans with zero employer
contribution, 67% had a positive credit balance at the beginning of 2001 while 64%
had a positive credit balance at the beginning of 2002. The remaining plans would
have been exempt from making a contribution on account of other reasons such as
the application of the Full Funding Limit.
The rationale behind the proposal for the elimination of the credit balance is that
a plan may be underfunded and yet not receive an employer contribution on account
of application of a positive credit balance. Table 4 examines the prevalence of
underfunded pension plans with a positive credit balance. For purposes of Table 4,
underfunded pension plans were defined as those plans for which the fair market
value of plan assets was lower than the Current Liability as of the beginning of the
plan year.
27 (...continued)
Term Budgetary Challenges, GAO-05-772T.
28 If only large plans are considered the proportion of plans with a positive credit balance
at the beginning of the 2002 plan year would be even larger. According to the PBGC, of all
plans considered for their PIMS Model, 86% had a positive credit balance at the beginning
of the 2002 plan year. The 1998 Pension Insurance Data Book states that the PIMS data
base has approximately 400 pension plans, sponsored by about 250 firms, which represent
about 50% of liabilities and underfunding in the defined benefit plan system. These are
among the largest plans in the defined benefit system.

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CRS-19
Table 4. Prevalence of Positive Credit Balance for Underfunded
Single-Employer Plans
Number of Plans
Category of Plans
2001
2002
All
29,315
28,265
Current liability > Market value of assets
15,299 (52%)
16,253 (58%)
Current liability > Market value of assets
2,579
2,074
but no employer contribution for year
Current liability > Market value of assets,
no employer contribution for year and
1,829
1,417
positive credit balance at BOY
Source: The Congressional Research Service (CRS) analysis of Form 5500 Schedule B data.
Note: Only plans covered by the PBGC and that had filed the Schedule B were considered.
As Table 4 illustrates, the proportion of underfunded pension plans was 52%
at the beginning of the 2001 plan year, and increased to 58% at the beginning of the
2002 plan year. The proportion of underfunded plans that received no employer
contributions for the year was 17% for 2001 and a somewhat lower 13% for 2002.
Of the underfunded plans with no employer contribution, 71% had a positive credit
balance at the beginning of 2001 while 68% had a positive credit balance at the
beginning of 2002, which presumably was the major reason for the plan not receiving
an employer contribution for the year.29
Interest on the credit balance is credited at the rate assumed by the plan actuary
for funding purposes. Table 5 shows the variation in the assumed interest rate for
plan years 2001 and 2002.
The average interest rate assumed was 7.1% for plan year 2001 and 7.0% for
plan year 2002. According to the PBGC, the average assumed interest rate tends to
be higher for larger plans. For the 2001 and 2002 plan years, for example, PBGC
analysis indicates that the average assumed interest rate for plans with 100 or more
participants was 8.0%. A typical pension plan invested 60% in large-cap stocks and
40% in long-term corporate bonds would have earned -3.75 % in 2001 and -9.16%
in 2002.30
29 Some of the plans may not have received an employer contribution for other reasons such
as the application of the Full Funding Limitation.
30 Common stocks assumed to track the S&P 500 stock index and bonds assumed to track
the Lehman Brothers Aggregate Bond Index.

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CRS-20
Table 5. Funding Interest Assumption for Single-Employer
Pension Plans
Percent of Plans
Interest Rate
2001
2002
<6%
13%
17%
> or = 6%, < 7%
26%
24%
> or = 7%, < 8%
26%
25%
> or = 8%, < 9%
30%
30%
> or = 9%
5%
4%
Source: The Congressional Research Service (CRS) analysis of Form 5500 Schedule B data.
Note: Only plans covered by the PBGC and that had filed the Schedule B were considered.
Some have suggested the following alternatives to the elimination of the credit
balance:
(1) Allow use of the credit balance in the FSA but accrue interest on it at the actual
rate earned by the pension trust for the year rather than the long-term interest rate
assumed by the plan’s actuary.
(2) Allow use of the credit balance in the FSA but do not accrue interest on it.
Appendix 2 illustrates the effect of these alternate approaches on a hypothetical
plan’s minimum required contribution and funded status. The illustration in the
appendix shows that the change in the minimum required contribution on account of
the above two approaches is small compared to the impact of disallowing use of the
credit balance.
Use of Fair Market Value instead of Actuarial Value. Under current
law, the minimum required and maximum deductible contribution rules allow use of
the actuarial value of assets rather than the fair market value of assets. In years in
which the investment return on plan assets is negative, the actuarial value for a plan
may be higher than the market value of assets since it may defer the recognition of
capital losses. This was the case for many plans in years 2000, 2001, and 2002, when
the S&P 500 returns were -9.19%, -11.87%, and -22.10% respectively. The result
for such plans was that the funding requirements were lower than would have
resulted from use of the fair market value of plan assets.
Under the Administration proposal, the fair market value of assets would be
used to determine the funding requirements as well as the unfunded liability for
calculation of the variable rate PBGC premiums. Table 6 below shows the
relationship between actuarial value and fair market value based on data obtained
from Form 5500 filings for 2001 and 2002.

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CRS-21
Table 6. Ratio of Actuarial Value to Market Value for
Single-Employer Pension Plans
Percent of Plans
AV/MV as of Valuation Date
2001
2002
< 0.9
2%
1%
> or = 0.9, < 1
9%
5%
1
66%
63%
> 1, < or = 1.1
12%
10%
> 1.1, < or = 1.2
5%
17%
MV = 0
5%
5%
Source: The Congressional Research Service (CRS) analysis of Form 5500 Schedule B data.
Note: Only plans covered by the PBGC and that had filed the Schedule B were considered.
In 2001, there were more plans with an actuarial value greater than the market
value (17%) than plans with an actuarial value lower than the market value (11%).
This pattern was even more pronounced in 2002. Twenty-seven percent of plans had
an actuarial value greater than the market value while 6% of plans had an actuarial
value lower than the market value.
Reactions to Administration Proposal
Although some have applauded the Administration proposal for taking a broad,
comprehensive approach to pension reform rather than providing temporary
solutions, business as well as labor have raised several objections.31 These include
the following:
! Volatility — Elimination of smoothing in the determination of the
interest rate and asset value and the ban on use of the credit balance
will result in far greater volatility in the minimum required pension
contribution.
! Credit Balance — Elimination of the credit balance is not fair to
employers that have made plan contributions in excess of the
minimum required amounts in the past with the expectation that
these could be used to reduce future contributions. Also, elimination
of the credit balance will create a disincentive for making plan
contributions in excess of the minimum required amount.
! Counter-Cyclical — Required contributions and PBGC premium
increases would be highest for companies experiencing financial
difficulty who can least afford them. This could lead to more
bankruptcies, plant closings, and layoffs.
31 See for example, Funding Our Future: A Safe and Sound Approach to Defined Benefit
Pension Plan Funding Reform by the American Benefits Council, at
[http://www.americanbenefitscouncil.org/documents/fundingpaper021604.pdf] and
testimony by United Auto Workers before the Senate Committee on Health, Education,
Labor and Pensions on Apr. 26, 2005, at [http://help.senate.gov/testimony/t269_tes.html].

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CRS-22
! Access to Surplus Assets — Although the Administration proposal
will raise the maximum deductible contribution ceiling, companies
will be reluctant to make higher contributions unless they are
allowed to access “super-surpluses” for legitimate purposes such as
payment of other employee benefits.
! Disruption of Capital Markets — The lack of asset and liability
smoothing in the new funding rules may drive employers to move
pension investments from stocks to bonds in order to reduce
volatility. This is likely to result in a decline in stock prices as well
as in interest rates offered on bonds.
! PBGC Premiums Too High — Proposed premiums will be too high,
especially for a company experiencing financial difficulty. This,
combined with higher funding requirements for such companies,
could lead to many employers freezing or terminating their defined
benefit pension plans.
! PBGC Powers to Set Premiums — At a minimum, Congress should
set limits on how large the PBGC premium increases can be and
how well PBGC should be funded.
! Transition — A transition period of three years or more is needed to
allow financial markets to accommodate pension funds’ shift from
stocks to bonds.
! Public Policy Does Not Favor Defined Benefit Plans — With lower
tax rates for capital gains and stock dividends, employers have little
incentive to provide pension benefits as compared to cash
compensation. One suggestion is that the Congress tax pension
distributions at the same rates as capital gains and stock dividends
in order to provide a level playing field.
Administration and other federal government response to business and labor
objections was included in several testimonies offered on the Hill.32 H.R. 2830 and
S. 1783 incorporate several elements of the Administration proposal but in modified
forms so that the impact on plan sponsors will generally be lower.
32 See for example, GAO testimony before the House Committee on the Budget, Private
Pensions: The Pension Benefit Guaranty Corporation and Long-Term Budgetary
Challenges, June 9, 2005, at [http://www.gao.gov/new.items/d05772t.pdf]; PBGC testimony
before the House Subcommittee on Transportation and Infrastructure, June 22, 2005, at
[http://www.pbgc.gov/media/news-archive/ExecutiveTestimony/tm13159.html]; CBO
testimony before the Senate Committee on the Budget, The Pension Benefit Guaranty
Corporation: Financial Condition, Potential Risks, and Policy Options, June 15, 2005, at
[http://www.cbo.gov/ftpdocs/64xx/doc6426/06-15-PBGC.pdf].

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CRS-23
Appendix 1. Measures of Pension Liability
Current pension law requires calculation of at least four separate measures of
pension liability that are used for different purposes. Not only are these defined
differently, but a different interest rate is used for valuing each liability. Table 7
highlights the differences between these measures of liability.
Two other measures of pension liability are used in accounting disclosure.
Publicly traded companies must file annual reports under Securities and Exchange
Commission requirements that include disclosure of the funded status of pension
plans. The funded status is based on a measure of pension liability called the
Projected Benefit Obligation (PBO). The PBO as of a certain date is the actuarial
present value of all benefits attributed by the pension benefit formula to employee
service rendered prior to that date. The PBO is measured using assumptions as to
future compensation levels if the pension benefit formula is based on those future
compensation levels. In addition, underfunded pension plans must disclose the
Accumulated Benefit Obligation (ABO).33 The ABO as of a certain date is the
actuarial present value of all benefits attributed by the pension benefit formula to
employee service rendered prior to that date and based on employee service and
compensation prior to that date. The ABO differs from the PBO in that it includes
no assumption about future compensation levels. The interest rate used to determine
the PBO and ABO is typically the rate on high quality long-term bonds during the
period to maturity of pension benefits.
33 For more information on the PBO and ABO, see Statement of Financial Accounting
Standards No. 87: Employers’ Accounting for Pensions, by the Financial Accounting
Standards Board.

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CRS-24
Table 7. Measures of Liability Under Pension Law
Authorization
Liability
Definition
Uses
Interest rate
and Rationale
Accrued
Portion of Present
AL less Actuarial
Rate chosen by
ERISA (1974)
Liability
Value (PV) of
Value of assets is
plan’s actuary
r e q u i r e d
(AL)
t o t a l b e n e f i t s
spread over a
such that along
systematic funding
associated with the
number of years
w i t h o t h e r
of the unfunded
past under the
specified by law
assumptions it
AL. It provided
a c t u a r i a l c o s t
in calculating the
represents his
flexibility in the
method chosen for
m i n i m u m
best estimate of
choice of actuarial
funding.
r e q ui r e d a n d
anticipated plan
cost method and
m a x i m u m
experience.
interest rate.
d e d u c t i b l e
p e n s i o n
contribution.
Current
PV of benefits
U s e d t o
Interest rate
I n s t i t u t e d b y
Liability
earned to date by
d e t e r m i n e
m u s t f a l l
OBRA 87 to bring
(CL)
employees based
o v e r r i d e s t o
between 90%-
more uniformity to
on service and
m i n i m u m
100% of four
determination of
compensation to
r e q ui r e d a n d
year weighted
minimum required
date. Includ es
m a x i m u m
a v e r a g e o f
a n d maxi mu m
liability for non
d e d u c t i b l e
interest rates on
d e d u c t i b l e
vested benefits.
c o n t r i b u t i o n s
l o n g - t e r m
contributions.
determined under
corporate bonds
t h e p l a n ’ s
(for 2004 and
funding method.
2005).
Present
Liability for retiree
PV of vested
85% of interest
V a r i a b l e r a t e
Value (PV)
pension benefits
b e n e f i t s l e s s
rate on long-
p r e m i u m s
of vested
a n d b e n e f i t s
actuarial value of
term corporate
instituted in 1987
benefits
earned to date by
plan assets used
bonds (for 2004
in order to charge
v e s t e d a c t i v e
to determine the
and 2005).
higher premiums
participants based
v a r i a b l e r a t e
to higher risk
on service and
PBGC premiums
plans.
compensation to
payable by the
date.
plan.
Termination
PV of benefits
M u s t b e
Rate used by
Authorized by
Liability
payable to plan
disclosed to the
private insurers
Section 4010 of
participants if plan
P B G C b y
t o p r i c e
ERISA. Provides
w e r e t o b e
employers with
i m m e d i a t e
PBGC information
t e r m i n a t e d .
plans that have
annuities for
for determining its
Includes vested as
a g g r e g a t e
r e t i r e e s a n d
e x p o s u r e f o r
well as unvested
unfunded present
d e f e r r e d
r e a s o n a b l y
benefits.
value of vested
annuities for
p o s s i b l e a n d
benefits greater
a c t i v e
p r o b a b l e
than $50 million.
e m p l o y e e s .
terminations.
This is usually
c o n s i d e r a b l y
lower than rates
u s e d t o
determine other
t y p e s o f
liabilities.
Source: The Congressional Research Service (CRS).

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CRS-25
Appendix 2. Illustrative Impact of Alternate Credit
Balance Proposals on Minimum Required
Contribution and Funded Ratio
Determined in the example below is a hypothetical plan’s minimum required
contribution under the following alternatives:
(a) Current law.
(b) Administration proposal — No credit balance carryover in the
Funding Standard Account.
(c) Allow use of the credit balance in the FSA but accrue interest on
it at the actual rate earned by the pension trust for the year rather than
the interest rate assumed by the plan’s actuary.
(d) Allow use of the credit balance in the FSA but do not accrue
interest on it.
In addition, illustrated for the four alternatives is the effect on the plan assets
and the funded ratio, assuming that the employer makes a contribution to the plan
equal to the minimum required contribution. For purposes of this appendix, the
funded ratio is defined as the ratio of the plan’s current liability to the market value
of plan assets.
The example chosen for this illustration was modeled after airline pension plans
that were underfunded in recent years, yet made no pension contribution on account
of a high credit balance. The information used was from the 2002 Schedule B of the
Form 5500 for certain airline pension plans to guide the use of plan characteristics
chosen for the illustration. However, in order to keep the illustration simple and
protect confidentiality, entries were not matched exactly to any one airline pension
plan’s Schedule B. Consider a plan with the characteristics shown in Table 8.
Table 8. Plan Characteristics for Illustration
Market value of assets — beginning of year (BOY)
$20,000,000
Current liability
$22,000,000
Benefit payout for year
$2,000,000
Current liability — end of year
$22,000,000
Credit balance at BOY
$700,000
Interest earned for year
-9.16%
Interest assumed for year
9.0%
Source: Congressional Research Service (CRS) assumptions.

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CRS-26
Table 9. Minimum Required Contributions Under Alternate
Credit Balance Proposals
Interest on
Administration
No Interest
Current
Credit
Proposal - No
on Credit
Law
Balance at
Credit Balance
Balance
(a)
Earned Rate
(b)
(d)
(c)
Charges to funding standard account
(1) Normal cost as of Jan. 1
$360,000
$360,000
$360,000
$360,000
(2) Amortization charges as
$300,000
$300,000
$300,000
$300,000
of Jan 1.
(3) Interest = .09 ((1)+(2))
$59,400
$59,400
$59,400
$59,400
(4) Total charges =
(1)+(2)+(3)
$719,400
$719,400
$719,400
$719,400
Credits to funding standard account
(5) Prior year credit balance
$700,000
$0
$700,000
$700,000
(6) Interest
$63,000
$0
($64,120)
$0
(7) Total credits = (5)+(6)
$763,000
$0
$635,880
$700,000
Minimum required
$0
$719,400
$83,520
$19,400
contribution = (4)-(7)
Source: Congressional Research Service (CRS) calculations.
Note: Interest on Normal Cost and Amortization charges under all four alternatives is calculated at
the assumed rate of 9%.
Table 9 shows the development of the Funding Standard Account and the
minimum required contribution under alternatives (a), (b), (c), and (d). Under all
four alternatives, lines (1), (2), (3), and (4), which represent charges to the FSA, are
identical. However, the values in line (5) are different depending on whether the
alternative allows the credit balance to be used as an offset. Also, the values in line
(6) are different depending on the rate used to credit interest on the credit balance.
As Table 9, Alternative (a) illustrates, under current law, the large credit
balance of $700,000 at the beginning of the plan year leads to no pension
contribution being required for the year. Under the Administration proposal —
Alternative (b), the credit balance would not be recognized in developing the
minimum required contribution. This results in the minimum required contribution
increasing from $0 to $719,400. If the credit balance is taken into account in the
calculations, but interest is accrued on it at the earned rate of -9.16% rather than the
assumed rate of 9% — Alternative (c), the minimum required contribution would be
a relatively low $83,520. Finally, if the credit balance is taken into account in the
calculations, but no interest is accrued on it — Alternative (d), the minimum required
contribution would be an even lower amount of $19,400.

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CRS-27
Table 10 develops the plan assets at the end of the plan year if the employer
makes plan contributions equal to the minimum required contributions under
alternatives (a), (b), (c), and (d) respectively as developed in Table 9. Table 10 also
shows the effect on the funded ratio under the different alternatives. If no
contribution is made as permitted under current law — Alternative (a), the market
value of assets would drop from $20 million at the beginning of the year to $16.17
million at the end of the year, thereby reducing the funded ratio from 0.91 at the
beginning of the year to 0.73 at the end of the year. Under the Administration
proposal — Alternative (b), the contribution would be $719, 400. This helps offset
some of the asset loss and results in a funded ratio of 0.77 at the end of the year. If
the employer makes plan contributions as required under Alternative (c) or
Alternative (d), plan assets at the end of the year would be higher than under current
law, but lower than under the Administration proposal. As a result, the funded ratio
at the end of the year under either Alternative (c) or Alternative (d) is 0.74, somewhat
better than under current law and considerably lower than the one produced under the
Administration proposal.
Table 10. Plan Assets and Funded Ratios Under Alternate
Credit Balance Proposals
Interest on
Administration
Credit
No Interest on
Current Law
Proposal No
Balance at
Credit Balance
(a)
Credit Balance
Earned Rate
(d)
(b)
(c)
(1) Market value of
$20,000,000
$20,000,000
$20,000,000
$20,000,000
assets — BOY
(2) Current liability
$22,000,000
$22,000,000
$22,000,000
$22,000,000
BOY
Funded ratio —
0.91
0.91
0.91
0.91
BOY = (1)/(2)
(3) Contribution
$0
$719,400
$83,520
$19,400
(4) Benefit payout
$2,000,000
$2,000,000
$2,000,000
$2,000,000
(5) Market value of
assets — end of
$16,168,000
$16,887,400
$16,251,520
$16,187,400
year = (1)*(1-
.0916)+(3)-(4)
(6) Current liability
$22,000,000
$22,000,000
$22,000,000
$22,000,000
— end of year
Funded ratio — end
0.73
0.77
0.74
0.74
of year = (5)/(6)
Source: Congressional Research Service (CRS) calculations.
The impact of the alternate credit balance proposals on the minimum required
contribution and funded ratio will depend on values of specific variables including
the interest rate earned by plan assets, actuarial interest assumption, the credit balance
at the beginning of the year, market value of plan assets at the beginning of the year,

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CRS-28
and current liability at the beginning and end of the year. This Appendix is intended
to illustrate the impact of alternate proposals on a hypothetical plan rather than
provide an exhaustive analysis of the impact of alternate proposals on the universe
of plans with a wide range of varying characteristics. However, the impact on the
minimum required contribution of recognizing the credit balance with zero interest
or market rate of interest would generally be small relative to disallowing use of the
credit balance.
crsphpgw

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