1. PBGC’s Underfunding Problem Beth Janus Jess Strilich

2. Funding Status from 1980 - 2004 Source: Paul Davies’ “Pension In Peril” 2001: $7.73 billion surplus 2004: Approximately $23.3 billion underfunded 2006: Approximately $18.1 billion underfunded

3. Steel Industry: The Beginning of the PBGC’s Problem American steel companies had problems remaining competitive against foreign competitors American steel companies had problems remaining competitive against foreign competitors American steel facilities were outdated compared to foreign competitors American steel facilities were outdated compared to foreign competitors Foreign competitors’ labor costs ranged from $20 to $30 per ton, while American firms’ labor costs were $100 per ton Foreign competitors’ labor costs ranged from $20 to $30 per ton, while American firms’ labor costs were $100 per ton

4. Steel Industry: The Beginning of the PBGC’s Problem cont. In order to stay competitive, the American steel companies used their free cash flow to update their steel mills In order to stay competitive, the American steel companies used their free cash flow to update their steel mills The steel companies implemented these changes too late and ultimately were forced into bankruptcy The steel companies implemented these changes too late and ultimately were forced into bankruptcy As a result, the PBGC received more than $6 billion in claims from the steel industry As a result, the PBGC received more than $6 billion in claims from the steel industry Bethlehem Steel - $3.7 billion Bethlehem Steel - $3.7 billion LTV Steel - $2.2 billion LTV Steel - $2.2 billion

5. What caused pension plans to become underfunded? Companies used accounting loopholes to satisfy minimum funding requirements Companies used accounting loopholes to satisfy minimum funding requirements The major loophole: Funding Standard Accounts (FSA) The major loophole: Funding Standard Accounts (FSA)

6. Funding Standard Accounts Companies use FSAs to monitor the health of its pension plans Companies use FSAs to monitor the health of its pension plans When the pension plan performs well or gains interest, the company stores the increase on the plan’s assets in an account (FSA) to accumulate value and eventually uses these gains to offset any future liabilities When the pension plan performs well or gains interest, the company stores the increase on the plan’s assets in an account (FSA) to accumulate value and eventually uses these gains to offset any future liabilities

7. Funding Standard Accounts cont. Since many pension plans were generating high returns from 1995 - 2001 Since many pension plans were generating high returns from 1995 - 2001 Companies used its accumulated gains from the FSA to meet minimum funding requirements rather than cash contributions (perfectly legal) Companies used its accumulated gains from the FSA to meet minimum funding requirements rather than cash contributions (perfectly legal) From 1997 to 2002, cash contributions averaged only 42 percent of minimum required annual funding From 1997 to 2002, cash contributions averaged only 42 percent of minimum required annual funding

8. Funding Standard Accounts cont. The companies relied heavily on the FSAs short-term benefits and did not prepare for an economic collapse The companies relied heavily on the FSAs short-term benefits and did not prepare for an economic collapse When steel companies ran out of FSA credits to fulfill minimum credits, the companies had no excess cash to fund their pension plans because they were spending their money to remain competitive When steel companies ran out of FSA credits to fulfill minimum credits, the companies had no excess cash to fund their pension plans because they were spending their money to remain competitive

9. PBGC’s Corporate Governance The PBGC has three board of directors (BOD) The PBGC has three board of directors (BOD) The Secretary of Labor, Chairman The Secretary of Labor, Chairman The Secretary of Commerce The Secretary of Commerce The Secretary of Treasury The Secretary of Treasury The 2006 PPA requires the Senate to elect a Director to oversee the PBGC operations The 2006 PPA requires the Senate to elect a Director to oversee the PBGC operations

10. Criticism of the PBGC’s Corporate Governance The BOD have only conducted 18 board meetings over the last 27 years The BOD have only conducted 18 board meetings over the last 27 years 10 of these meetings have been conducted after 2003 10 of these meetings have been conducted after 2003 The BOD still has not established formal policies and procedures for administration The BOD still has not established formal policies and procedures for administration The reason: The Department of Labor still heavily influences the PBGC The reason: The Department of Labor still heavily influences the PBGC

11. How is the PBGC going to solve its underfunding problem?

12. PBGC Recent Alternatives PBGC increase premium to $33 for FY2008 PBGC increase premium to $33 for FY2008 Will adjust for inflation based on the average wage index Will adjust for inflation based on the average wage index Proposes Variable-Rate Premium Proposes Variable-Rate Premium Underfunded plans require increased payments Underfunded plans require increased payments Benefits to be measured as of the funding valuation date Benefits to be measured as of the funding valuation date Ensure premium is determined the same way and at the same time when the fund is valued, no estimation required Ensure premium is determined the same way and at the same time when the fund is valued, no estimation required

13. PBGC Recent Alternatives Propose adjusting the mortality assumption to determine benefit for beneficiaries Propose adjusting the mortality assumption to determine benefit for beneficiaries Update tables for interest factors to match the market annuity prices Update tables for interest factors to match the market annuity prices Currently the tables no longer approximate the market annuity prices Currently the tables no longer approximate the market annuity prices Update using a fixed blend of 50% healthy female mortality rate and 50% healthy male mortality rate Update using a fixed blend of 50% healthy female mortality rate and 50% healthy male mortality rate

14. Criticism of PBGC’s Proposal Premium Adjusted for Inflation: Premium Adjusted for Inflation: Companies freeze its pension plans Companies freeze its pension plans Mercer study: Of the Fortune 200 companies approximately 20% have frozen its pension plans or closed to new employees Mercer study: Of the Fortune 200 companies approximately 20% have frozen its pension plans or closed to new employees Pension decreased from 100,000 company plans in 1985 to less than 40,000 plans in 2006 Pension decreased from 100,000 company plans in 1985 to less than 40,000 plans in 2006 Companies rather than bear additional costs to fully fund and pay higher premiums opt for 401(k) Companies rather than bear additional costs to fully fund and pay higher premiums opt for 401(k) Shift retirement burden on workers. Shift retirement burden on workers.

15. Criticism of PBGC’s Proposal Variable Interest Premiums: Variable Interest Premiums: Company performing subpar, difficult for firm to pay the increased PBGC premiums due to its increased risk Company performing subpar, difficult for firm to pay the increased PBGC premiums due to its increased risk Company focused on withstanding bankruptcy and producing net income Company focused on withstanding bankruptcy and producing net income Decreases companies incentive to maintain pension plan Decreases companies incentive to maintain pension plan

16. Bush Alternatives for PBGC Agree with the PBGC, the premiums do not match the associated risk of all companies Agree with the PBGC, the premiums do not match the associated risk of all companies Propose PBGC’s board adjust the risk-based premium rate so that the premium revenue can cover potential expected losses Propose PBGC’s board adjust the risk-based premium rate so that the premium revenue can cover potential expected losses Goal DB plans to better reflect a plan’s risk and restore PBGC health Goal DB plans to better reflect a plan’s risk and restore PBGC health Potential Problems with Alternative Potential Problems with Alternative Bring question of who determines how much companies pay? Bring question of who determines how much companies pay? Who will monitor the premiums and fluctuations in pension funding? Who will monitor the premiums and fluctuations in pension funding? 3 major board members 3 major board members Congress will not approve b/c cede legislative authority to set premiums to administration agencies Congress will not approve b/c cede legislative authority to set premiums to administration agencies

17. Our Alternatives Of the companies that sent claims to the PBGC for funding needs, 90% had junk bond rating for the last 10 years Of the companies that sent claims to the PBGC for funding needs, 90% had junk bond rating for the last 10 years PBGC better prepare itself for company claims by monitoring companies pension liability bond rating PBGC better prepare itself for company claims by monitoring companies pension liability bond rating Difficult to solve for underfunding but need to plan for possible termination Difficult to solve for underfunding but need to plan for possible termination

18. Our Alternatives Incentive for companies to adequately fund pension plan Incentive for companies to adequately fund pension plan Through tax credits or tax deductions Through tax credits or tax deductions Current law has penalty for funding large amounts in profitable years for tax purposes Current law has penalty for funding large amounts in profitable years for tax purposes Reduce this penalty so companies will fund and less stress on the PBGC Reduce this penalty so companies will fund and less stress on the PBGC Discourages companies to make sufficient cash infusions b/c penalized for overfunded plans Discourages companies to make sufficient cash infusions b/c penalized for overfunded plans

19. Our Alternatives Companies should receive a tax credit for interest and gains in its liability account Companies should receive a tax credit for interest and gains in its liability account Required to contribute a stated minimum level of cash infusion per year Required to contribute a stated minimum level of cash infusion per year Decrease risk of potential future pension plan failure in hard economic times Decrease risk of potential future pension plan failure in hard economic times Help reduce the stress on the PBGC in the case of terminated plans Help reduce the stress on the PBGC in the case of terminated plans

20. Recommendations Problem is difficult to solve Problem is difficult to solve Agree with variable risk premiums Agree with variable risk premiums Insurance companies use similar method for pension insurance, government should do the same Insurance companies use similar method for pension insurance, government should do the same Issue with potential frozen plans Issue with potential frozen plans Rather have 401K plan and phase out pensions than have an extremely risky pension plan Rather have 401K plan and phase out pensions than have an extremely risky pension plan PBGC needs better risk management PBGC needs better risk management 18 BOD meetings in last 27 years 18 BOD meetings in last 27 years Recently increased the number of board meetings but remain under prepared for large claims Recently increased the number of board meetings but remain under prepared for large claims

21. Questions??????