EXECUTIVE DIRECTOR'S MESSAGE

Following the historic losses recorded by the pension insurance program in 2002, the Pension Benefit Guaranty Corporation (PBGC) sustained additional severe losses during 2003 amid deepening concern for the health of the private defined benefit pension system. Defined benefit pension plans continue to be an important source of retirement security for more than 44 million American workers. However, the funded status of these plans has deteriorated sharply and a number of plan sponsors have been unable to meet their benefit obligations, leading to record deficits in both of PBGC’s insurance programs. Despite the financial pressures on the Corporation, PBGC continued to meet the growing demand placed upon it for benefit payments while making further progress in customer service.

LOSSES CONTINUED

Under PBGC’s single-employer plan insurance program, losses from completed and probable plan terminations totaled nearly $5.4 billion for 2003, significantly less than the record amount experienced in 2002. This represented PBGC’s second largest annual loss from plan terminations in its 29-year history, continuing a three-year-old trend of steep losses for the pension insurance program.

These losses represent more than just claims against the insurance program. When PBGC is forced to take over underfunded plans, the burden often falls heavily on workers and retirees. In some cases, participants lose benefits that were earned but not guaranteed by the insurance program. In all cases, workers lose the opportunity to earn additional benefits under the terminated plan.

PBGC’s premium payers—the employers who sponsor defined benefit pension plans—also pay a price when an underfunded plan terminates. When PBGC takes over such plans, financially healthy companies with betterfunded pension plans end up making transfers to financially weak companies with chronically underfunded plans.

In a counterpoint to PBGC’s losses from terminations, the Corporation’s investment program produced income in excess of $3.3 billion. However, as substantial as it was, the Corporation’s investment income only offset about half of the actuarial charges arising largely from interest rate changes. Even with the investment income, PBGC is reporting a net loss for the year of $7.6 billion primarily due to losses from terminated plans and actuarial charges, pushing the single-employer program’s year-end deficit to $11.2 billion. At year-end the total liability for guaranteed benefits exceeded $44.6 billion compared to less than $29 billion one year ago.

Figure - Net Position, Single-Employer Program, 1994-2003 - This line chart shows that the PBGC’s single-employer program net year-end financial position increased from a deficit of $1.2 billion in 1994 to a record surplus of $9.7 billion in 2000, then fell to a record deficit of $11.2 billion in 2003.

PBGC’s separate insurance program for multiemployer plans, which is vulnerable to some of the same economic and demographic pressures that have threatened the single-employer program, also sustained a substantial loss for the year. The multiemployer program reported a net loss of $419 million, the largest one year drop in the program’s history. This result is largely due to PBGC’s recording of new probable losses from future financial assistance for several additional plans as well as from the decline in interest rates. Consequently, the multiemployer program is reporting a year-end deficit of $261 million, the program’s largest shortfall ever and its first year-end deficit in over 20 years.

Figure - Net Position, Multiemployer Program, 1994-2003 - This line chart shows that the year-end net position of PBGC’s multiemployer program fluctuated from a surplus of $197 million in 1994 to a record surplus of $341 million in 1998, falling thereafter to a record deficit of $261 million in 2003.

The financial state of both insurance programs is cause for concern. The single-employer program’s $34 billion in assets, and the multiemployer program’s $1 billion in assets, provide PBGC with sufficient liquidity to pay benefits for a number of years. However, neither program at present has the resources to fully satisfy PBGC’s long-term obligations to plan participants. Moreover, PBGC estimates that the total underfunding in single-employer plans exceeded $350 billion as of fiscal year-end. Underfunding in multiemployer plans has increased as well, reaching an estimated $100 billion as the year closed. This underfunding prompts an additional concern for the multiemployer program because the underfunding is concentrated in mature, often declining industries. Given the limited size of the multiemployer program, the failure of a large, highly underfunded plan could overwhelm the program’s financial capacity.

The Bush Administration has recognized the urgency of the financial challenges facing private pension plans and PBGC’s insurance programs and has alerted the public to its concerns. The Administration’s concerns were affirmed in 2003 when the General Accounting Office (GAO) placed PBGC’s single-employer program on its “high-risk” list. It should be noted that GAO’s action did not reflect concerns about management of the pension insurance program, as GAO pointed out in Congressional testimony. Rather, GAO’s report to the Congress pointed to structural problems in the private-sector defined benefit system that pose serious risks to PBGC.

The funding of America’s private pension plans is a pressing public policy issue. Financial market trends from 2000 through 2002— falling interest rates and equity returns—have exposed underlying weaknesses in the pension system, weaknesses that must be corrected if the system is to remain viable in the long run. The defined benefit system faces other challenges as well, including an asset-liability mismatch, adverse demographic trends, and weaknesses in the pension funding rules.

Figure - Total Underfunding in Insured Single-Employer Plans, 1994-2003 - This bar chart shows an increase in underfunding in the single-employer program from more than $60 billion in 1994 to an estimated $350 billion in 2003.

The concurrent drops in both equity values and interest rates, in particular, have undermined the financial strength of most defined benefit pension plans in recent years. Pension plan liabilities tend to be bond-like in nature. For example, both the value of bonds and the value of pension liabilities have risen in recent years as interest rates fell. Were interest rates to rise, both the value of bonds and the value of pension liabilities would fall. The value of equity investments is more volatile than the value of bonds and less correlated with interest rates. Most companies prefer equity investments because they have historically produced a higher rate of return than bonds. These companies are willing to accept the increased risk of equities and interest rate changes in exchange for expected lower pension costs over the long term. Similarly, labor unions support investing in equities because they believe it results in larger pensions for workers. Investing in equities rather than bonds shifts some of these risks to PBGC.

Demographic trends are another structural factor adversely affecting defined benefit plans. Many defined benefit plans are sponsored by employers in the nation’s oldest and most capital intensive industries. These industries face growing pension and health care costs due to an increasing number of older and retired workers. Retirees already outnumber active workers in some industries with substantially underfunded plans. Furthermore, Americans are living longer in retirement as a result of earlier retirement and longer life spans. Today, an average male worker spends 18.1 years in retirement compared to 11.5 in 1950, an additional 7 years of retirement that must be funded.

Another concern is weaknesses in the current funding rules, most notably the low limits set for funding targets. Employers can stop making contributions when a pension plan is funded at 90 percent of “current liability.” However, current liability doesn’t reflect the plan’s termination liability, which is the full cost of providing annuities as measured by group annuity prices in the private market. For example, in its last filing prior to termination, Bethlehem Steel reported that it was 84 percent funded on a current liability basis. At termination, however, the plan was only 45 percent funded on a termination basis, with total underfunding of $4.3 billion.

The funding rules also often allow “contribution holidays” even for seriously underfunded plans. For example, in the case of the U.S. Airways pension plan for pilots, which PBGC trusteed in March with unfunded benefits totaling $2.2 billion, the company made no cash contributions to the plan for four years prior to plan termination. And, because of the structure of the funding rules under ERISA and the Internal Revenue Code, defined benefit plan contributions can be extremely volatile. After years of the funding rules allowing companies to make little or no contributions, many companies are facing substantial increases in their contributions at a time when they are facing other economic pressures.

Figure - Average Number of Years Spent in Retirement (Males) - This bar chart, in five-year increments from 1950-1955 to 1995-2000, shows the number of years an average male worker spends in retirement. Today, an average male worker spends 18.1 years in retirement compared to 11.5 in 1950.

Fundamental changes in the funding rules are needed to put plans on a predictable, steady path to better funding. At the same time, we must keep in mind that the defined benefit pension system is voluntary. We must balance reforms against any new disincentives for companies to maintain their pension plans. By strengthening the funding rules to minimize volatility in contribution requirements but still ensure that all companies make the contributions needed to back their pension promises, we will make it more attractive for plan sponsors to retain their defined benefit plans.

The Administration believes that the first step toward responsible reform of pension funding rules is to improve the accuracy and transparency of pension information. To this end, the Administration has proposed an initial package of legislative reforms to respond to the challenges facing the defined benefit system. The proposals include specific recommendations to more accurately value pension liabilities, to increase disclosure about the funded status of plans, and to require immediate funding of additional benefits in severely underfunded plans at high risk of termination.

In addition to these proposals, the Administration is developing comprehensive reforms to strengthen the defined benefit system by getting pension plans better funded. We also believe that PBGC’s premiums should be reexamined to see whether they can better reflect the risk posed by various plans to the pension system as a whole.

Benefit Operations Expanded

In addition to our growing financial concerns, we also are coping with unprecedented growth in our benefit operations. In the past two years, PBGC has assumed responsibility for the benefits of nearly 400,000 people, equal to the number the Corporation took in during its first 21 years of operation. PBGC took on responsibility for some 206,000 workers and retirees in 152 plans trusteed during 2003 alone. This was the largest number of new beneficiaries ever absorbed in one year by the insurance program, topping the previous record set just last year. The trusteed plans also included the largest single plan ever handled by PBGC, that of Bethlehem Steel Corporation, which covered 95,000 participants including 67,000 retirees.

By the end of 2003, PBGC was responsible for a total of 3,240 trusteed plans and the current and future pension benefits of about 934,000 participants, including 100,000 participants in multiemployer plans receiving financial assistance from PBGC. An additional 47 terminated single-employer plans were pending trusteeship at year-end.

During 2003, PBGC paid benefits totaling nearly $2.5 billion to more than 459,000 people. This was up from the previous record amount of $1.5 billion, paid in 2002, and it was $1.4 billion more than we paid just two years ago.

PBGC’s insurance program for multiemployer plans approved requests for financial assistance from two additional plans during 2003. These requests raised to 33 the total number of plans that have received financial assistance from PBGC, out of the more than 1,600 insured plans. Since 1980, PBGC has provided assistance with a total value of approximately $162 million net of repaid amounts. During the year, 24 plans received financial assistance totaling about $5 million.

Customer Service Improved

Although faced with a huge surge in new people owed guaranteed benefits, PBGC increased its performance in issuing final benefit determinations. During 2003, the Corporation issued over 92,000 benefit determinations, more than in any previous year. On average, PBGC issued the final determinations only 2.2 years after the date it had trusteed the participant’s plan, exceeding the performance goal of a 3-year average set for 2003 under PBGC’s strategic plan. This was the shortest amount of time the Corporation has ever needed to produce final benefit determinations, achieved despite the historic increase in PBGC’s workload.

Our recent efforts to improve efficiency have also contributed to improved customer service. Procedural innovations applied and tested in the termination of the LTV Steel plans in 2002, such as advance coordination with the plan sponsor before the plan’s actual termination, early communications with plan participants, and specialized customer contact centers, helped ensure a virtually seamless transition to PBGC trusteeship in spite of the plans’ unusually large size. The new procedures and lessons learned from LTV were applied on a greater scale in 2003, allowing PBGC to absorb Bethlehem Steel’s even larger plan without compromising our customer service or processing goals. Another recent improvement—accelerated issuance of benefit determinations for people whose benefits are uncomplicated or unaffected by adjustments— enabled PBGC to increase its output of final determinations to cope with the growing demand. These innovations have markedly improved productivity and efficiency. Consequently, PBGC’s customers are receiving higher quality service, as their increasing satisfaction attests (please see the Annual Performance Report, later in this Annual Report, for details).

Further improvements in customer service will be achieved through greater use of information technology. Our electronic government initiative, including Web-based methods of communication, will strengthen PBGC’s ability to provide premier service for its rapidly growing customer base.

Throughout 2003, PBGC continued efforts to develop fully functional online self-service centers. Once implemented, these accounts will enable participants in trusteed plans and plan practitioners to access their personal or plan-related information and conduct a range of transactions any time of day on any day of the year. Late in 2003 PBGC initiated a small-scale test of a pilot self-service center for participants called “My Pension Benefit Account” that allows online updating of certain personal information. PBGC also began testing and refining a prototype of a similar self-service facility, called “My Plan Administration Account,” for administrators of PBGC-insured plans and the pension practitioners who assist them. The Corporation plans a phased rollout of initial versions of these self-service accounts to its customers beginning in 2004.

PBGC is also pressing forward with other initiatives aimed at upgrading its information technology and enhancing its service capabilities. We have begun testing a Customer Relationship Management (CRM) application that uses a combination of technology and streamlined business processes to improve PBGC’s responsiveness to customer inquiries. During this past year PBGC also implemented a new Knowledge Management application that allows PBGC’s operations staff to preserve and easily share knowledge about innovations and lessons learned in processing the recent large plan terminations.

Customer service at PBGC is a dynamic concept grounded on continual improvement, and we are looking ahead to other projects that have significant implications for PBGC and its customers. For example, we are re-engineering the business processes for premium payments and standard terminations as the first step in redesigning the Corporation’s automated premium accounting system to better serve plan practitioners. Other projects for which planning is underway include integration of PBGC’s financial systems, improved automated systems for performing plan valuations and benefit calculations, and application of independent verification and validation testing to all of the Corporation’s major automated systems.

While many of our initiatives are driven by our business needs, others arise from customer comments. We now use the American Customer Satisfaction Index (ACSI) to measure our customers’ satisfaction with our services and to gain insight into needed improvements. The ACSI index is a sophisticated, internationally accepted index compiled annually from surveys by a partnership of the University of Michigan Business School, the American Society for Quality and the CFI Group. It offers an independent, objective third-party measure that can help PBGC identify and prioritize areas needing improvement. PBGC’s latest ACSI scores, described later in the Annual Performance Report section of this Annual Report, demonstrate the progress we are making in addressing our customers’ needs and wants.

Final Thoughts

The federal pension insurance system and the pension plans it protects now face serious challenges. PBGC’s staff is responding with increased efficiency, productivity, and concern for the needs of our customers. However, fundamental changes are needed to put the defined benefit system and PBGC’s insurance program on a stable long-term footing. The Bush Administration is actively engaged in formulating appropriate solutions and we will be working with Congress to craft the necessary reforms. The retirement security of American workers demands no less.

Steven A. Kandarian
Executive Director

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