EXECUTIVE DIRECTOR'S MESSAGE

The federal pension insurance program administered by the Pension Benefit Guaranty Corporation occupies a critical position in the nation's infrastructure of retirement laws, policies and programs. As a guarantor of pensions for more than 44 million Americans, the program is the lone backstop for hundreds of billions of dollars in promised but unfunded retirement benefits. As the trustee and administrator of nearly 3,500 failed defined benefit pension plans, the program is a primary source of retirement income and security for more than 1 million Americans whose benefits would have been lost without PBGC's protection. As the defined benefit system has come under pressure-from pension underfunding, changing workforce demographics and increased competition from companies with lower cost structures that do not include defined benefit pensions-so, too, has the insurance program. This was starkly evident in 2004, as the program sustained the largest financial losses in its history.

However, these losses were only one of the challenges confronting the insurance program during 2004. PBGC also faced a swelling workload as it assumed administrative responsibility for the benefits of nearly 150,000 additional participants in failed single-employer pension plans. No less demanding were PBGC's efforts to monitor, measure and mitigate the varied and growing risks facing the pension insurance program. All of this occurred alongside the need to continue to raise the level of service PBGC provides to its customers. The financial, operational and policy challenges facing PBGC have never been greater. By improving our processes, adopting new technology solutions and strengthening our workforce, we are responding to the challenges. We are committed to providing the highest level of customer service and to ensuring a more secure retirement for American workers and retirees.

Administering Program Finances

PBGC's ability to manage its finances is severely limited. Unlike a private insurer, PBGC cannot control its revenues and cannot control its expenses. PBGC's premiums are set by Congress, and companies sponsoring insured pension plans can transfer their unfunded liabilities to PBGC as long as they meet the statutory criteria. In 2004, the single-employer insurance program posted its largest loss and largest year-end shortfall in the agency's 30-year history. For the year, completed and probable pension plan terminations required PBGC to record financial losses totaling $14.7 billion. By year-end, these losses had more than doubled the program's deficit to $23.3 billion.

Net Position, Single-Employer Program 1995-2004

It must be emphasized that PBGC has sufficient assets on hand to continue paying benefits for a number of years. However, with $62.3 billion in total liabilities against only $39 billion in total assets, the single-employer program lacks the funds to pay a significant portion of the future benefits for which it is obligated. In addition, the program remains exposed to $96 billion in potential losses from underfunded plans sponsored by non-investment-grade companies.

PBGC's separate program for multiemployer plans recorded net income of $25 million due primarily to the program's income from premiums and investments, which more than offset additional losses recorded for future nonrecoverable financial assistance. At year-end, the multiemployer program reported a reduced deficit of $236 million.

Net Position, Multiemployer Program 1995-2004

The Corporation is doing all it can to monitor its finances and manage its resources. PBGC's 12th consecutive unqualified opinion on its financial statements from its independent auditors attests to the quality of PBGC's financial reporting. Additional validation comes from the Department of the Treasury's Financial Management Service, which monitors federal agencies' performance in meeting financial reporting standards. Using its "traffic light" grading system, FMS gave PBGC scores of “green” signifying that the agency had successfully met all standards for the accuracy and timeliness of its financial reporting.

In recognition of the evolving emphasis on financial reporting, during the year the Corporation completed an extensive review of its internal controls and the related control framework. This project was designed to identify, document, test, correct and report on all of PBGC's key financial controls. Its results provide another level of assurance about the accuracy and integrity of PBGC's financial systems and information.

PBGC also initiated changes within the past year to enable it to better manage the financial risks facing the pension insurance program. The first of these was adoption of a new investment policy that will reduce the Corporation's risks resulting from a mismatch between PBGC's assets and liabilities. The policy calls for the Corporation to increase its investment in fixed-income securities that match the duration of its liabilities. When fully implemented, PBGC's investment strategy will result in a less volatile financial performance and a reduction in the agency's overall risk. Through this strategy, any change in the value of PBGC liabilities will be more closely offset by a corresponding change in the value of the fixedincome assets, reducing the risk of an increased PBGC deficit resulting from interest rate changes. PBGC will implement the policy in 2005 by increasing its investment in fixed-income instruments as it acquires assets from newly trusteed plans.

Another initiative will improve PBGC's ability to gather, analyze and act on pension plan funding information and to respond to marketplace developments in a timely manner. As part of an overall reorganization, the Corporation is establishing a new Office of Risk Assessment to strengthen its capability to measure and manage risks to the pension insurance program. This office, which will report directly to the Executive Director, will analyze industry and economic risks to PBGC's financial strength and the pension insurance system.

The current massive underfunding of defined benefit pensions, compounded by the financial struggles of major industries that rely heavily on these pensions, has greatly increased the risk of loss for the pension insurance program. In response, PBGC is monitoring the financial condition of more plans more closely to manage its risks and minimize losses for the insurance program. When necessary, PBGC will move forcefully, in negotiation or litigation, to protect the benefits of plan participants and the interests of the insurance program.

During 2004, PBGC took action in several high-profile bankruptcies, particularly in the airline industry. In the case of United Air Lines, which is ongoing, PBGC has acted to enforce the company's obligation to continue funding its defined benefit plans while undergoing reorganization in bankruptcy. PBGC also secured an important bankruptcy court ruling in a dispute with US Airways. That court rejected the airline's challenge to the amount of PBGC's claim for underfunding in the US Airways pension plan for pilots, which PBGC trusteed in 2003. The ruling was a victory for the financial integrity of the federal pension insurance program and affirmed that PBGC's claim against sponsors who terminate their pension plans is governed by ERISA, not bankruptcy law.

PBGC's intervention in the still-pending bankruptcy of Enron Corporation promises to secure valuable additional funding for the benefits of Enron employees. Out of concern that the company's proposed plan of reorganization made inadequate provision for either maintaining four of Enron's defined benefit plans or placing the pension obligations with a private sector insurer, PBGC initiated proceedings to terminate the plans. That action, and PBGC's objection to the disposition of certain Enron assets, led Enron to agree to place several hundred million dollars in an escrow account to fund a standard termination of the plans. Standard termination would preserve full benefits for the plans' participants and protect the insurance program from any loss in this case.

While willing to negotiate appropriate settlements, PBGC continued to actively litigate cases across the country, several of which resulted in important rulings for the insurance program. For example, as the year came to a close, an appeals court ruled for PBGC in reversing an earlier district court decision setting the termination date for several plans sponsored by Republic Technologies International. PBGC had sought a termination date before the declared shutdown of the company but the district court chose a later date. The appeals court found that the lower court failed to give appropriate deference to PBGC's conclusion that it faced an unreasonable increase in liabilities if the court selected a termination date after the shutdown. By upholding the earlier date, the appeals court protected the insurance program from absorbing an additional $96 million in unfunded shutdown benefits that were neither funded nor insured by the company.

Meeting Customers' Needs

Nothing is more important to PBGC than providing the highest quality service to its customers. The Corporation has an intense focus on meeting the needs and expectations of its customers while carrying out its statutory missions. This focus enabled PBGC to improve customer service in 2004 as investments in information technology and implementation of new work procedures allowed more efficient casework without a significant increase in staff.

In recent years, a priority of PBGC has been the establishment of online services that customers could access at their convenience through the Internet. In 2004, the Corporation unveiled two types of self-service accounts, one for participants in PBGC-trusteed plans and the other for administrators of PBGC-insured plans and the pension practitioners who assist them. These new facilities, available through PBGC's Web site, enable the participants and plan practitioners to interact electronically with PBGC and conduct a range of transactions any time of day, year-round.

For participants, this service is called My Pension Benefit Account (My PBA). It allows all participants to review and change their personal information, and retirees may use it to sign up for electronic direct deposit of their benefit payments, change banking information, and change information on their federal tax withholding. Future improvements to My PBA will allow participants to electronically access, complete and submit the Corporation's most frequently used forms and to submit online requests for benefit estimates.

Plan administrators and practitioners may now use My Plan Administration Account (My PAA), the other new self-service application, to electronically create, route, sign and submit premium filings and payments to PBGC. This system, which requires no special software, offers a number of advantages over paper submissions: improved data accuracy, easier filing preparation, shared electronic access to filings (which eliminates manual routing and mailing), e-mail notification of required actions, and confirmation that the filing and payment were received by PBGC. The Corporation is examining ways to expand this service to allow, for example, the electronic filing of other required submissions.

PBGC's Web site continued to evolve in other ways. For example, the population of people owed a guaranteed benefit from PBGC includes a growing number for whom Spanish is their primary language. To improve service and the availability of understandable information to the Corporation's growing population of Spanish-speaking customers, within the past year PBGC increased the amount of translated materials and created a dedicated section on its Web site for those materials. PBGC also initiated a master redesign of its Web site to make it more user-friendly and easy to navigate. That new Web site is scheduled to go online in 2005.

The Corporation is constantly upgrading the technology used throughout its operations. During 2004, PBGC completed testing of a new application that will expedite plan valuations and benefit calculations, thus facilitating PBGC's ability both to process terminated plans and to provide benefit determinations to plan participants. The application eventually will allow non-retired participants in PBGC-trusteed plans to develop estimates of their future benefits on their own without waiting for PBGC to complete its calculations. Benefit estimates are a primary concern of many of these future retirees. By providing these estimates faster, the new application should markedly increase their satisfaction with PBGC's service.

PBGC also has begun an effort to replace its existing automated premium accounting system in order to improve service to plan administrators and pension professionals. Initial steps in 2004 included re-engineering and redesigning the current business practices involved in premium collections. Completion of the project is targeted for 2005.

While some of the changes implemented during the year resulted from technological improvements, others took place on the policy and personnel fronts. As a service to its pension practitioner customers, the Corporation announced a new, temporary Voluntary Correction Program for administrators of underfunded plans who had failed in the past to issue required notices to plan participants about the plan's funding status and limitations on PBGC's guarantee. This program allows plan administrators to provide a corrective notice and avoid the penalty that otherwise would be imposed for failure to provide the notices. In association with the VCP, PBGC proposed an expanded enforcement program, including a new penalty structure, to assure that the notices are properly provided in the future. The Voluntary Correction Program, which has the dual aim of encouraging plan administrators to correct recent compliance failures and facilitating future compliance, is intended as a transition to the new enforcement program.

Improved service leads to improved satisfaction among customers, as PBGC saw in 2004. The Corporation uses the American Customer Satisfaction Index (ACSI) to measure customers' satisfaction with its services and to gain insight into needed improvements. The ACSI index is a sophisticated, internationally accepted index compiled annually 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 in the Annual Performance Report later in this Annual Report, demonstrate the progress the Corporation is making in addressing its customers' needs. For example, participants who called PBGC for assistance were highly satisfied with many aspects of the service they received. As a result, they provided PBGC with an ACSI score of 78 that exceeded both PBGC's goal for the year and the score for the federal government as a whole (72). Retirees, in particular, were extremely satisfied with PBGC, providing an ACSI score of 84. During 2004, PBGC began surveying users of its Web site to test customer satisfaction across all channels of communication (telephone, mail and Web). Initial results indicated a need for further improvements to the Web site, and PBGC's implementation of better online services is expected to increase users' satisfaction significantly in coming months.

In another sign of PBGC's commitment to premier customer service, the Corporation provided final benefit determinations-perhaps its most sought-after service other than benefit payments-with heightened efficiency. During 2004, the Corporation issued more than 137,000 benefit determinations to participants in trusteed plans, nearly 50 percent more than the previous record number of 92,000 issued the previous year. PBGC issued these determinations, on average, 2.2 years after the date it had trusteed the participant's plan, maintaining the pace set in 2003. Not only did PBGC issue more determinations, but it did so with lower rates of errors and of appeals by plan participants.

Strengthening Operations

PBGC is using all means at its disposal to cope with the rising demands on the federal pension insurance program and administer the program more efficiently and effectively.

PBGC has distinguished itself by constantly evolving in response to the ever-changing challenges it faces. Two years ago, the Corporation restructured its Strategic Plan and operating budget so that they better reflected PBGC's two lines of business: 1) administering the insurance programs covering more than 44 million participants in 31,200 ongoing pension plans, and 2) providing pension benefits for the one million participants in nearly 3,500 PBGC-trusteed plans.

During 2004, the Corporation's executive management decided to realign its resources to better identify and address emerging issues in the regulated community of ongoing plans. To achieve optimal use of PBGC's resources, attorneys, financial analysts and actuaries will join together in a new Insurance Program Department. This department will handle the enforcement and bankruptcy- related functions previously assigned to several departments including the Office of the General Counsel. Final implementation of this plan will take place in 2005 following negotiations between management and the union representing PBGC's staff. As part of this restructuring, PBGC plans to create an Office of Consumer Affairs, which would conduct educational programs for the public and participants in PBGC-insured plans, develop joint ventures with outside groups, and improve the Corporation's informational literature for the public and PBGC's customers.

The insurance program continued to experience unprecedented growth in its benefit operations throughout the year as it assumed responsibility for 178 additional terminated single-employer plans and the benefits of nearly 150,000 people. Although fewer new participants were taken in by the insurance program than in 2003, the larger number of plans trusteed substantially increased PBGC's administrative workload since each plan requires its own set of audits and benefit calculations. By the end of 2004, PBGC was responsible for a total of 3,418 trusteed plans and the current and future pension benefits of about 1,061,000 participants, including 100,000 participants in multiemployer plans receiving financial assistance from PBGC. An additional 61 terminated single- employer plans were pending trusteeship at year-end. PBGC is now paying about $250 million in benefits each month, twice as much as it was paying just two years ago.

PBGC's insurance program for multiemployer plans approved requests for financial assistance from five additional plans during 2004. These requests raised to 39 the total number of plans that have received financial assistance from PBGC, out of the 1,600 insured plans. Since 1980, PBGC has provided assistance with a total value of about $174 million net of repaid amounts. During the year, 27 plans received financial assistance totaling about $10 million.

The Corporation's performance management system and strategic planning fared favorably in PBGC's first Program Assessment Rating Tool (PART) review by OMB. PART is a systematic method of assessing the performance of program activities within agencies and across the federal government with the goal of improving program performance. This review holds programs to high standards — simple adequacy or compliance with the letter of the law is not enough. Rather, a program must show it is achieving its purpose and that it is well managed. PBGC's overall PART rating of “moderately effective,” the second highest rating possible, reflected the quality of PBGC's performance management and its effectiveness in meeting ambitious targets. Notably, PBGC earned high scores (greater than 85) in the areas of program management and strategic planning. While PBGC performed well in areas under the Corporation's statutory control, OMB's official summary on the PART review noted that “... ERISA (the statute under which PBGC operates) prevents it from following many insurance industry best practices regarding premium structure, risk management, funding rules and benefit determinations. The Administration supports legislative reform to remove the statutory barriers to improving in these areas.”

PBGC recognizes that managing its workforce is as important as managing its operations. The Corporation has an active succession management program in place to assure that a cadre of managers will be prepared to compete for vacant leadership roles, and it regularly conducts mentoring programs to promote the career development of its employees. This year the Corporation completed a human capital strategic plan designed to ensure that PBGC has the employees, contract staff, work environment and operating culture necessary to accomplish its mission in the face of a rapidly changing environment with an increasing workload. The plan uses the framework recommended by the U.S. Office of Personnel Management, with an emphasis on six key areas: strategic alignment, workforce planning and deployment, leadership and knowledge management, results-oriented performance culture, talent, and accountability.

Reforming the System

While PBGC is doing all it can within the current statutory framework to protect the integrity of the federal pension insurance program, it is clear that legislative changes are necessary to ensure the program's long-term viability. For several years, the Bush Administration and PBGC have called for policy and statutory changes to ERISA. We will be working with Congress to effect the necessary reforms in 2005.

The principal structural flaw is an overly complex set of funding rules for defined benefit plans. These rules saddle financially healthy companies with perverse incentives not to fully fund their plans while allowing financially troubled companies to forgo funding their promises for many years.

A second flaw is “moral hazard.” A properly constructed insurance system has mechanisms for encouraging responsible behavior and discouraging risky behavior. The federal pension insurance program lacks these basic checks and balances. There are no risk-based underwriting standards and few consequences for not funding pension promises. If a company promises more than it is able to afford, it can shift the cost of the benefits to other companies, including competitors, through the insurance program.

Another flaw is the lack of transparency in the pension system. Publicly available information about pension plans often is stale and misleading. The system's opaqueness discourages accountability and market discipline, and key stakeholders are prevented from responding effectively to current problems. Worst of all, workers are often the last to know of problems with their pension plans.

Finally, the Corporation's ability to protect the interests of plan participants and premium payers is extremely limited, especially when a plan sponsor enters bankruptcy. Currently, the agency has few tools at its disposal other than to move to terminate a plan.

Given the serious challenges facing the pension insurance program, no amount of tinkering will achieve the lasting solution needed to put the insurance program on a sound footing and to restore the confidence of workers and retirees who rely on PBGC's pension protection. Only a considered and comprehensive approach will improve the financial health of the private defined benefit system, protect participants' benefits, and return the insurance program to financial strength.

These reforms should take several forms. We must streamline and strengthen the current funding rules to provide sounder pension funding. Weaknesses in current law should be eliminated to ensure that troubled plans are brought closer to full funding, and the rules should be simpler and provide greater flexibility to financially healthy plan sponsors.

We must implement a rational premium structure for the pension insurance program. This structure should meet the program's long-term revenue needs, provide incentives for full funding of covered plans, and appropriately reflect the risks faced by the program, including both potential claim incidence and claim severity.

We must require more timely, meaningful information on pension plans' funding levels. This will ensure that those with a stake in the pension system-workers, retirees, investors and regulator-can make decisions based on current, accurate information.

Lastly, PBGC needs better tools to carry out its statutory responsibilities in an effective way. Providing the insurance program with additional options would strengthen the program while prompting creditors to encourage better plan funding.

Closing Observations

The defined benefit system and the federal insurance program that stands behind it are being tested more severely than at any time since enactment of ERISA 30 years ago. At stake is the viability of one of the principal means of providing stable retirement income to millions of American workers. Although the challenges are multi-faceted, defy easy answers and demand a careful balancing of interests to devise workable solutions, such solutions are achievable. The time to act is now.

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