News & Policy
Understanding the Financial Condition of the Pension Insurance Program
The Pension Benefit Guaranty Corporation (PBGC) is a federal corporation created under the Employee Retirement Income Security Act of 1974 (ERISA). It insures the pensions of about 33.8 million workers and retirees in nearly 28,000 private-sector defined benefit pension plans under its single-employer insurance program. PBGC insurance funds pay guaranteed benefits that are not funded by plan assets or recoveries from employers at plan termination.
As of September 30, 2008, the end of the 2008 fiscal year, PBGC reported a $10.7 billion deficit in the financial statements for its single-employer pension insurance program.
Below are questions and answers about what the deficit means, how it is calculated, and the true cost of the PBGC insurance program. The questions also address measures of pension underfunding in the defined benefit system.
A: PBGC's financial statements are prepared in conformance with Generally Accepted Accounting Principles, the same standards that apply to publicly traded companies across the United States. The financial statements are reviewed by PBGC's Inspector General and subjected to a complete independent audit by a private-sector auditing firm. For fiscal year 2008, PBGC received its 16th consecutive clean (i.e., unqualified) audit opinion from its independent auditors. A clean audit opinion requires consistent and accurate valuations and estimates.
PBGC's financial condition is determined by comparing the values of its assets and its liabilities. PBGC's assets consist primarily of accumulated premiums paid by covered plans (invested in Treasury securities) and plan assets that PBGC has taken over when it becomes trustee of terminated underfunded plans. PBGC's liabilities consist primarily of future benefit payment obligations both for trusteed plans and for those deemed likely to default. PBGC values both its assets and liabilities at market value.
Group annuity prices are the most objective measure of the cost of settling a plan's liabilities in the marketplace. PBGC uses group annuity prices to value its liabilities. This assures parity between the valuation of liabilities in plans taken over by PBGC and the cost of providing annuities when a company voluntarily terminates a plan and, by law, provides annuities through the purchase of annuities in the marketplace. The annuity-price methodology upholds the important principle that it should not be cheaper to terminate a pension plan with the PBGC than with a private insurance company. Moreover, it is the basis that has been used more than 171,000 times since 1974 whenever companies have terminated plans, including fully funded plans that close out without the use of PBGC insurance funds. For more information, see PBGC Procedure for Setting Interest Factors Used to Value Liabilities for PBGC Financial Statements.
A: The deficit includes losses incurred from plans that have already terminated and estimated losses incurred from "probable" terminations. A plan is classified as a probable termination if PBGC determines that it is likely the plan will terminate. Generally, a plan is classified as a probable termination if the employer is in liquidation and there are no related companies that could fund the plan; the employer has filed for a distress termination; or PBGC is seeking involuntary plan termination. Other criteria, such as a bankruptcy filing or the sponsor's default on a credit agreement in combination with other factors, also may be used to classify a plan as a probable termination. Once a plan is classified as a probable termination, it remains a probable until it either terminates or is no longer expected to terminate with a loss to the insurance program.
A: Generally Accepted Accounting Principles (GAAP) and the Financial Accounting Standards Board Statement No. 5, Accounting for Contingencies, require PBGC to include probables in its liability for future pension benefits that PBGC will be obligated to pay participants. Specifically, expected losses must be included if the loss is likely to occur and the amount of the loss can be estimated. PBGC's balance sheet and deficit as of September 30, 2008, included $3.2 billion in net losses from probable terminations.
The accounting standards require probables to be reported in PBGC's balance sheet on a net basis. That is, the estimated present value of plan assets and employer recoveries is subtracted from the estimated present value of benefits to be paid by PBGC and the resulting net figure is reported on PBGC's balance sheet, rather than reporting plan assets as PBGC assets and plan benefits as PBGC liabilities. Accounting rules do not permit plan assets to be booked as PBGC assets until the PBGC takes over the plan assets.
A: Historically, the majority of plans booked as probable losses subsequently terminate. At the end of fiscal year 2008, of the $36.6 billion in probable net claims booked by PBGC in Fiscal years 1987 through 2008, $24.2 billion (66%) had terminated, $9.4 billion (26%) were removed from the probables category, and $3.0 billion (8%) were unresolved. Thus, 72% of the $33.6 billion of resolved probable claims had terminated. No new significant large plans were classified as probable terminations in 2008.
Q: When a plan terminates that was already included on PBGC's books as a probable, what is the effect on PBGC's deficit?
A: The loss that PBGC reports from a completed termination is the present value of future benefits assumed by PBGC, less the present value of plan assets and expected recoveries, all measured as of the actual date of plan termination. Generally there is no significant effect on PBGC's deficit when a plan that is classified as a probable termination actually terminates, because probables are already included in the deficit. However, there can be changes in the amount of the reported loss, partly because any re-measurements after the original date often are able to take into account updated information and assumptions not available when the original estimate was made.
A: Generally, plans are classified as "reasonably possible" to terminate if they are sponsored by companies with a higher default risk â€‘ e.g., companies whose bonds are rated below investment grade. As of December 31, 2007, there was $47 billion of underfunding in plans that, as of September 30, 2008, were classified as reasonably possible terminations. In accordance with Generally Accepted Accounting Principles and the Financial Accounting Standards Board Statement No. 5, Accounting for Contingencies, PBGC is required to disclose its exposure to losses from reasonably possible terminations in footnotes to PBGC's financial statements. Unlike losses from completed and probable terminations, these potential losses are not included in the PBGC's balance sheet or deficit.
A: Every time PBGC takes on more assets from an underfunded terminated plan, it also takes on new benefit liabilities that exceed the amount of the new assets. While PBGC has enough assets to cover benefits for a number of years, taking on more terminated plans makes the long-term problem worse, not better.
I. Measuring the Pension Insurance Program Deficit
A: The deficit reported in PBGC's financial statements is not intended to be a representation of the insurance program's long-term economic cost. Rather, it is calculated as required under Generally Accepted Accounting Principles, which mandate taking into account claims from probable terminations in the near term but not future claims over the long term. The deficit, therefore, is not a measure of the program's long-term economic cost.
A: PBGC evaluates future claims and the financial condition for the single-employer insurance program using a stochastic model, the Pension Insurance Modeling System (PIMS), to simulate thousands of combinations of economic parameters and bankruptcy rates. As stated in PBGC's 2008 Annual Report, PIMS projects that:
- the median outcome is a $22.6 billion deficit in 2018 (in present value terms). This means that half of the PIMS' simulations show either a smaller deficit than $22.6 billion, or a surplus, and half of the simulations show a larger deficit;
- the average outcome is a $26.3 billion deficit in 2018 (in present value terms); and
- the probability of a financial statement surplus of any amount by 2018 is 26 percent.
A: Total underfunding in PBGC-insured single-employer defined benefit plans, measured on a termination basis, is a measure of exposure in the defined benefit system; this measure does not assume that all plan sponsors are going to fail. All of this underfunding is in excess of what is shown on PBGC's balance sheet or included in its deficit.
PBGC estimates that, measured on a termination basis, total underfunding in single-employer defined benefit plans that PBGC insures was approximately $225 billion as of December 31, 2006. Because of concerns about limitations with respect to the estimation process, PBGC is no longer publishing estimates of total underfunding in its Annual Management Report. However, PBGC will continue to publish Table S-47, "Various Estimates of Underfunding in PBGC-Insured Plans," in its Pension Insurance Data Book where the limitations of the estimates can be appropriately described.
Q: How much of the total underfunding poses risk to plan participants, premium payers, and taxpayers?
A: Most of the underfunding in PBGC-insured single-employer plans is in plans sponsored by healthy companies that should be able to fund promised benefits over time. However, as of December 31, 2007, $47 billion of underfunding for vested benefits is in plans sponsored by companies whose bonds are rated below investment grade or who met one or more of the other criteria. According to rating-agency data, below-investment-grade companies are more than 20 times more likely to default on their debt obligations within 5 years than investment-grade companies.
A 2005 GAO report also identified the financial strength of a plan sponsor as a key determinant of risk to the PBGC. According to the report, of the PBGC's 41 largest claims since 1975 in which the sponsor's credit rating was known, 39 have involved plan sponsors that were rated as below-investment-grade three years prior to termination. These 39 claims account for 67% of the value of total gross claims on the single-employer program from 1975 to 2004. About 80% of the plan sponsors involved in these claims were rated as below-investment-grade 10 years prior to plan termination.
A: PBGC measures underfunding as if a plan were terminating today, by valuing assets and liabilities on a market basis. PBGC's value of benefits is based on the market cost of annuities (net of benefit administration expenses) that a private insurance company would charge to pay the plan's promised benefits in annuity form. This market-based measurement gives an objective snapshot of a plan's funded status at a particular point in time.
PBGC gathers annuity pricing data from private insurance companies through a quarterly survey, which is conducted for PBGC by the American Council of Life Insurers. The survey asks insurers to provide the price, net of administrative expenses, for annuity contracts for terminating plans. The survey methodology assures that PBGC's termination values reflect the market price of termination. PBGC has used the same methodology for many years, ensuring that termination values are consistently determined.
PBGC's termination-basis measure also takes into account that, when a plan of a financially weak company terminates, more individuals tend to retire early with subsidized benefits. These early retirements often substantially increase plan liabilities and, consequently, plan underfunding.
A: The assumptions that companies use to measure liabilities often understate a plan's underfunding compared to its underfunding on a termination basis. Companies report the funded status of their pension plans for a variety of purposes (corporate financial statements, required notices to participants, etc.). The measurement basis that companies use differs based on the purpose for which the funded status is being measured but the basis is rarely, if ever, a termination basis.
The main differences in measurement bases are the discount rate used to calculate the present value of benefits, the expected retirement age used to estimate when benefits will commence, the amount of early retirement benefits that will become payable, and the methodology used to value plan assets. For example, as a result of the Pension Protection Act of 2006, companies must report annually a plan's funded status to participants. For this purpose, both the discount rate and the asset value are generally smoothed over a 24-month period, which typically results in a higher funded status than would be determined using PBGC termination assumptions. As a result, participants in terminating plans may be alarmed to learn that their plan is much more underfunded than previously reported.
For example, Bethlehem Steel (terminated in 2003) reported that its plan was 84 percent funded, but the plan was only 45 percent funded on a termination basis, with a total shortfall of $4.3 billion. US Airways' pilots' plan (terminated in 2003) was 94 percent funded on an ongoing basis, but the plan was only 33 percent funded on a termination basis, with a $2.5 billion shortfall.
II. Measuring the Long-Term Cost of the Insurance Program
A: Simply stated, when underfunded pension plans terminate, workers and retirees, companies that have acted responsibly in honoring their pension promises, and, potentially, U.S. taxpayers are hurt. These terminations can have particularly harsh consequences for workers and retirees. While PBGC steps in to pay benefits to participants in terminated pension plans, some workers and retirees may lose benefits they were counting on to provide economic security in retirement if promised benefits exceed guarantee limits established by Congress.
For example, the total amount of underfunding in the four largest terminations in PBGC history was approximately $18.4 billion. About 87 percent of that shortfall was covered by PBGC. The remaining 13 percent (about $2.4 billion) represents the loss to plan participants. In other words, workers and retirees in these plans forfeited $2.4 billion of earned pension benefits, losses that can never be recovered. A recent study by PBGC using a much larger sampling of terminated plans found that about 96 percent of the total amount of underfunding in large plans was covered by PBGC, with the remaining 4 percent representing a loss to participants. This study also showed that 84 percent of the participants received all the vested benefits that they had earned under their plans. Each plan termination is different and, for participants who do not receive their full vested benefits, the magnitude of individual losses may be much less or much more than the above statistics show. Participants are most likely to be affected if their plans recently granted benefit increases, but participants who experience the largest reductions generally are those with benefits in excess of the maximum guarantee.
Besides workers and retirees, the other stakeholders in the system are companies with PBGC-insured plans. By law, PBGC is supposed to be self-financing. The principal source of revenue to pay unfunded guaranteed benefits is premiums paid by these companies. The premiums needed to pay for plan defaults might become too high for the defined benefit plan sponsors in the system, raising the prospect of either the need for general taxpayer assistance or a greater loss of benefits for insured participants.
It also is important to provide investors an accurate measure of pension liabilities. They have a financial interest in knowing the cost that companies would incur to settle their pension obligations through voluntary plan termination and the claim that PBGC would have against the company in the event of a distress or involuntary termination.
III. Consequences of the Deficit and Plan Underfunding
 Under a separate program, the PBGC guarantees the pensions of 10.1 million people covered by about 1,500 multiemployer plans.
 This approach is detailed in Note 2 ("Significant Accounting Policies") to PBGC's FY 2008 Financial Statements and was also the subject of 2005 and 2006 GAO reports. The 2005 report notes "PBGC stated its exposure for probable claims in accordance with FAS No. 5 as required by GAAP. Directed at the accounting objective of full disclosure, this standard requires the PBGC to record a loss if it is likely to occur and the amount of the loss can be reasonably estimated. PBGC's financial statement auditors routinely review this area and its compliance with GAAP requirements as part of their annual audit. PBGC has consistently used a method of spec ifically identifying potential claims supplemented by estimates for additional claims that might be missed by its method for selecting probable claims." (U.S. Government Accountability Office, Private Pensions: Questions Concerning the Pension Benefit Guaranty Corporation's Practices Regarding Single-Employer Probable Claims, GAO-05-991R Private Pensions, page 4, September 9, 2005.) The 2006 report states that GAO "found that PBGC's probable claims estimates are reasonable because they are generally close to final claim amounts that are determined for these plans that PBGC ultimately takes over." (U.S. Government Accountability Office, Private Pensions: Opportunities Exist to Further Improve the Transparency of PBGC's Financial Disclosures, GAO-06-429 Private Pensions, page 9, March 27, 2006.)
 Claims from terminated plans that have not yet been taken into PBGC trusteeship similarly are reported on a net basis in PBGC's balance sheet.
 PBGC disclosed this $47 billion of underfunding for vested benefits in plans of financially weak companies as reasonably possible terminations in Note 8 to the fiscal year 2008 financial statements.
 United States General Accountability Office, "Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules," GAO-05-294, pp. 30-36 (May 2005).
 Separately, PBGC periodically surveys the administrative expense charges of annuity providers and adds an allowance for those expenses to net prices generated by the annuity price survey.