United States of America: Selected Issues

This Selected Issues paper analyzes the United State’s (U.S.) household savings role in supporting the U.S. recovery; and focuses on the market for single-family housing, and the importance for household balance sheets. It discusses the underfunding of corporate pension plans, macroeconomic, and policy implications; the U.S. fiscal position, and reviews the causes of the fiscal crisis. It examines the impact of energy shocks, energy policy, and the taxation role. It analyzes the growth in linkages between the United States and other G-7 countries, and the regional and bilateral trade links issues.


This Selected Issues paper analyzes the United State’s (U.S.) household savings role in supporting the U.S. recovery; and focuses on the market for single-family housing, and the importance for household balance sheets. It discusses the underfunding of corporate pension plans, macroeconomic, and policy implications; the U.S. fiscal position, and reviews the causes of the fiscal crisis. It examines the impact of energy shocks, energy policy, and the taxation role. It analyzes the growth in linkages between the United States and other G-7 countries, and the regional and bilateral trade links issues.

III. Underfunding of Corporate Pension Plans: Macroeconomic and Policy Implications1

1. The importance of defined-benefit (DB) pension plans in the U.S. pension system has declined in recent years. Once a staple of employee compensation packages, these plans—which offer a pre-defined retirement income based on the number of years of service and salary level—are now concentrated in manufacturing and other sectors with heavily unionized labor forces. Instead, defined-contribution pension plans—in which benefits are based on pre-retirement contributions by workers and their employers—have become more prevalent, especially in rapidly growing sectors, reflecting the fact that these plans offer greater employee portability and pose less financial risk for employers. By 2002, assets in defined-benefit plans had fallen to around 15 percent of GDP, compared with assets in defined-contribution plans of over 20 percent of GDP (Figure 1).

Figure 1.
Figure 1.

Corporate Pension Plans: Total Assets

Citation: IMF Staff Country Reports 2003, 245; 10.5089/9781451839623.002.A003

2. DB plans have faced increasing financial pressures in recent years, reaching record levels of underfunding in 2002. This development has partly reflected the adverse demographic trends these plans are facing, as the number of retiree participants is expected to exceed the number of contributors for the first time in 2003 (PBGC, 2002). These structural pressures have been compounded by more recent financial market developments. The stock market decline has severely weakened the value of plan portfolios, given that a significant proportion of plan assets—55 percent in 1999—are invested in equities. In addition, the sharp drop in long-term interest rates has substantially increased the discounted present value of future liabilities.

3. The funding shortfall has potentially important macroeconomic and policy implications. Underfunded pension obligations have already acted as a drag on corporate profits and credit ratings for a number of major U.S. corporations. The recent failure of a number of large companies with significantly underfunded plans has also weakened the finances of the Pension Benefit Guarantee Corporation (PBGC), which is the federal agency that insures private pensions. These developments and related policy issues are analyzed in more detail below. The principal conclusion is that systemic consequences are a concern, but they are mitigated by the fact that underfunding is concentrated in only a few companies and could be alleviated significantly if the economy and financial markets continue to recover. At the same time, there would seem scope for strengthening the accounting treatment of DB pension plans and the financial position of the PBGC.

A. Factors Underlying the Erosion of DB Plans

4. The weakening of the financial position of defined-benefit pension plans has been a relatively recent phenomenon. In 1999, pension plans of firms in the S&P 500 had been overfunded, in net present value terms, by nearly $250 billion. However, by end-2001, this surplus was exhausted, and by end-2002, DB plans had a deficit estimated at $216 billion (CSFB 2003). Rating agencies have begun to scrutinize more closely the pension obligations in their assessments of firms’ credit worthiness, and have downgraded many companies with particularly large liabilities, causing their stock prices to fall and credit spreads to widen.

5. The funding shortfall largely reflects the impact of broader financial market developments. Pension plans had sought to limit their exposures to equity markets during the latter half of the 1990s, selling significant net amounts of equities (Figure 2). However, the rapid increase in equity prices still caused the share of pension plan assets held in equities to rise to around 55 percent by the end of the decade (Table 1). The subsequent collapse in stock market prices caused valuation losses totaling roughly $400 billion between end-1999 and end-2002. In addition, lower long-term interest rates used to discount future pension payouts have significantly increased the net present value of pension obligations.

Table 1.

Defined Benefit Corporate Pension Plans: Portfolio Composition

(In percent of total financial assets, end of year)

article image
Sources: Federal Reserve, Flow of Funds Accounts, and Fund staff calculations.
Figure 2.
Figure 2.

Defined Benefit Pension Plans: Net Purchases of Corporate Equities

Citation: IMF Staff Country Reports 2003, 245; 10.5089/9781451839623.002.A003

6. Tax regulations and the stock market boom also discouraged employer contributions to DB plans. In particular, contributions are only deductible for income tax purposes if the plan is underfunded, and contributions that take the plan above this point are subject to corporate income tax and an excise tax. With the stock market boom pushing plans into surplus, firms had an incentive to avoid making contributions, even in the face of net withdrawals by retirees.

7. Taken from a longer-term perspective, however, pension plans have made significant gains from their holdings of equities. For example, data from the Federal Reserve’s Flow of Funds accounts suggest that if the share of DB plan assets held in equities had been strictly limited to 40 percent from the 1980s, plan assets would have been $250 billion below their actual end-2002 level.2 Although significant losses occurred following the stock market collapse in 2000, these were more than offset by earlier capital gains, which averaged nearly $200 billion per year during the latter half of the 1990s. As a result, while cumulative stock market gains since 1985 have fallen sharply from a peak of $1.4 trillion in 1999, they remained at around $1 trillion at the end of 2002 (Figure 3).

Figure 3.
Figure 3.

Defined Benefit Pension Plans: Capital Gains and Losses

Citation: IMF Staff Country Reports 2003, 245; 10.5089/9781451839623.002.A003

8. These conclusions are illustrated by an examination of the finances of a representative sample of 19 underfunded pension plans. These 19 firms account for $110 billion of the total underfunding, or slightly more than half the total funding shortfall, for the S&P 500 as a whole (Table 2). Their reports to the SEC provide data that are not available on an aggregate basis, including changes in pension benefit obligations, actual gains or losses on plan assets contributions made to pension plans during the year, and benefits paid. For these companies, nearly half of the deterioration in funding levels since 2000 resulted from stock market losses, with the balance arising from an increase in benefit obligations (due to lower discount rates) and net payouts (Table 3). However, viewed over a longer time horizon—1997–2002—equity market holdings made a positive contribution to funding levels, in excess of $100 billion.

Table 2.

Funding Status of Defined Benefit Corporate Pension Plans

(Year-end; in billions of dollars)

article image
Source: Company 10–K reports.
Table 3.

Change in Funding Status of Defined Benefit Pension Plans

(Selected companies, billions of dollars)

article image
Sources: Company 10–K reports; Fund staff calculations.

B. Pension Funding and Profits

9. Funding shortfalls will need to be met by increased contributions, according to requirements specified by the Employee Retirement Income Security Act (ERISA) and the tax code. Underfunded plans are required to return to full funding over a five- to 30-year period. If a plan is less than 90 percent funded, additional contributions are required that would take the plan back to 90 percent within a three- to five-year period. This higher requirement only applies if the plan has been under the 90 percent threshold for two of the last three years, or if it is less than 80 percent funded.

10. However, further relief from these funding requirements can be obtained. For example, companies can apply for a three-year waiver of funding rules, and the Labor Department is able to extend by as long as ten years the period during which companies are required to amortize funding contributions. Congress also has considerable scope to ease funding pressures. For example, 1997 legislation eased funding requirements for the benefit of one specific transportation company, and legislation is presently being considered that would provide temporary relief to the airlines sector.3 Legislation in 2002 also raised the interest rate plans are required to use to calculate the present value of pension liabilities to 120 percent of the 30-year Treasury bond yield, and legislation is being considered that would allow plans to discount future pension liabilities using corporate bond rates.

11. Higher contributions will likely weigh on profits in coming years.4 Pension costs have already dampened profit growth in 2002, with firms in the S&P 500 tripling their pension contributions over the previous year to $46 billion. As a result, the growth of economic profits was kept to 7½ percent, 5 percentage points lower than would have been the case if contributions had been unchanged (CSFB, 2002).5 Looking ahead, many firms will need to increase contributions further. For example, benefit payments by the 19 firms examined above currently exceed the level of contributions by a factor of three.

12. However, a strong recovery could help strengthen the financial position of DB plans and ease the burden on profits. Higher growth would boost corporate cash flows, improve equity returns, and raise bond yields, all of which would ease the position of DB plans.6 In order to illustrate this point, staff macroeconomic simulations were constructed for 2003 and 2004: a baseline scenario corresponding roughly to the consensus forecast, and weaker and stronger scenarios around this baseline. Under the baseline scenario, S&P 500 firms would boost contributions and reduce the funding shortfall of their plans to $110 billion by end-2004, from $216 billion at end-2002 (Table 4). A stronger recovery, higher equity prices, and higher bond yields would allow firms to maintain contributions at their 2002 levels while still reducing underfunding to $65 billion. By contrast, a weaker recovery would require a large increase in contributions, sapping profit growth while still leaving pension plan shortfalls at $210 billion.7

Table 4.

Simulation of Pension Fund Finances

article image
Source: Fund staff estimates.

C. Pension Funding and the PBGC

13. Shortfalls in the defined-benefit pension system have weakened the financial position of the Pension Benefit Guarantee Corporation (PBGC). The PBGC—a federal agency that guarantees private DB pensions—is funded by premiums it charges sponsors of DB pension plans. During the past two years the PBGC has had to assume the liabilities of a large number of pension plans that failed, taking on an additional $9 billion in benefit obligations. This factor, as well as valuation losses on its own assets, caused the PBGC’s net actuarial position to erode significantly, falling into a $3½ billion deficit (Table 5).8

Table 5.

Financial Status of the Pension Benefit Guarantee Corporation

(Single-Employer Program, billions of dollars)

article image
Source: PBGC, Annual Report, 2002.

14. The financial shortfalls of the PBGC pose policy challenges. The size of the Corporation’s assets appears to preclude liquidity problems in the foreseeable future. Nonetheless, measures may still be required to address the PBGC’s actuarial deficit, especially in the event of significant additional failures of private sector plans. For example, stochastic simulations reported in the PBGC’s 2002 annual report suggest that, in the absence of measures, there is only a 30 percent probability that the PBGC would be in a surplus position by 2012.

15. The policy options involve difficult tradeoffs, however. The PBGC is not explicitly backed by the government, and it relies on premiums to fund its operations. Annual premiums are presently $19 per plan participant, with an additional charge to underfunded plans of $9 per $l,000 of unfunded vested benefits. Although a hike in premiums, or shifting further to risk-based premiums, could be considered, this could create an adverse selection bias, since healthier firms would be encouraged to terminate their DB pension plans by switching to defined-contribution or 401(k)-type pension plans. Indeed, the present system already contains “moral hazards,” since firms facing financial difficulty can continue to promise relatively generous pension benefits, which would have to be largely covered by the PBGC if the firm goes into bankruptcy.9 Thus, restoring the financial position of the PBGC may require a delicate balance between amending its premium structure and a proactive approach to ensuring that insured plans are operated prudently and in a manner that avoid imposing additional large obligations on the Corporation.10

D. Pension Accounting, Valuation, and Earnings

16. The weakness of DB pension plans has spurred greater attention to the accounting treatment of pension funds. Current accounting rules allow firms to calculate pension plan earnings using an expected return on pension assets, rather than actual returns. This rule allows firms to avoid having short-term asset price movements affect reported earnings, but may have the undesirable side-effect of obscuring firms’ underlying financial position, especially in the event of a prolonged market downswing.

17. Indeed, pension earnings have been significantly over-reported in recent years, following significant underreporting during the 1990s. The expected return assumed by companies has typically been based on a historical equity return over a period of ten years or so, and thus may have diverged from actual returns by significant amounts.11 In particular, while many firms have reduced expected return assumptions by a percentage point or more over the past two years, the median expected return is still above 8 percent, well above the sharply negative returns that funds actually achieved during 2001 and 2002. In the case of the representative sample of 19 firms described above, reported earnings exceeded actual returns by $130 billion during the past two years. Although the more recent over-statement of returns is roughly offset by the under-reporting of capital gains during 1995–1999, reported profits can be significantly mis-represented on a year-to-year basis.

18. Recent research suggests that the accounting treatment of defined-benefit pension plan assets also distorts equity valuations. Coronado and Sharpe (2003) examine the relationship between different categories of corporate earnings and stock market valuations, and find that valuations did not fully differentiate between core earnings and pension earnings. Their analysis suggests that investors placed “an unjustifiably high valuation” on firms with substantial pension earnings, reflecting insufficiently transparent accounting practices.12

E. Concluding Observations

19. The foregoing discussion suggests a number of points:

  • The financial problems of the DB pension plan system that have emerged in recent years do not appear to have been wholly the result of excessive investment in equities. The share of DB assets in equities rose during the latter half of the 1990s, but this largely reflected the effect of valuation gains, and valuation losses in recent years have not out-weighed earlier gains. Other factors, including insufficient contributions during the 1990s in the face of long-standing demographic problems, as well as the decline in bond yields, have also been important.

  • Although pension shortfalls may adversely affect corporate profits in the period ahead, these pressures may abate with an economic recovery. In the examples described above, a recovery in line with the consensus macroeconomic forecasts would significantly ease the burden on the system, by boosting stock market valuations and raising interest rates. However, baseline and weaker scenarios would still leave the underfunding significant and could pose continued pressures on some sectors and firms. Restoring the financial position of the PBGC is also likely to require additional measures, and care will be needed to ensure that insured firms do not impose additional burdens on the Corporation.

  • There is scope for improving the accounting of pension fund results, including by requiring more explicit reporting of the impact of plan returns on reported earnings. Although these data are reported in the footnotes to financial statements, transparency would be improved by including this information in a more prominent place in profit and loss statements.

  • A relaxation of tax penalties against contributions to fully funded pension plans could strengthen the financial position of plans. These tax rules were instituted to prevent firms from exploiting the tax-preferred nature of pension contributions. This concern should be balanced against the risk that the failure of a firm with large unfunded benefits jeopardizes the retirement income of employees, and may ultimately cause a burden on taxpayers. Allowing firms to deduct contributions to plans with some higher levels of funding—perhaps 110 percent rather than the current 100 percent limit—could help encourage full funding over the cycle, while still limiting the scope for tax avoidance.


  • Coronado, J. L., and S.A. Sharpe, 2003, “Did Pension Plan Accounting Contribute to a Stock Market ‘Bubble’?,Brookings Papers on Economic Activity, forthcoming.

    • Search Google Scholar
    • Export Citation
  • CSFB (Credit Suisse First Boston), 2002, The Magic of Pension Accounting.

  • New York Times, 2003, “Pension Reserves: What’s Enough” (June 22).

  • PBGC (Pension Benefit Guarantee Corporation), 2002, Annual Report, Washington, D.C.


Prepared by Calvin Schnure.


These data cover all pension plans, based on Form 5500 that plans must file with the Department of Labor. This form lists actual asset market values, rather than the assumed equity returns that are used to calculate reported earnings.


The discussion focuses on “economic” profits in the National Accounts, which provide the broadest measure of corporate earnings in the economy. Economic profits are free of many of the accounting distortions associated with firms’ earnings reports, and use actual contributions that firms make to pension plans as the measure of pension costs, rather than an estimate based on assumptions about future asset returns.


The 19 firms examined above accounted for nearly half this increase in contributions.


Projected Benefit Obligations (PBOs) are extremely sensitive to interest rates, and according to one estimate, each 50 basis point increase in interest rates reduces the PBO for S&P 500 firms by $60 billion (CSFB 2003).


However, to the extent that funding problems are concentrated in sectors with significant excess capacity—airlines and autos, in particular—the marginal impact on investment could be muted.


The PBGC also provides a multi-employer program to ensure plans that cover workers from many firms. This plan is much smaller and its total assets exceed total liabilities.


For 2003, the maximum pension guaranteed by the PBGC is about $44,000 per year for workers who retire at age 65 (lower amounts apply to younger participants).


The PBGC’s Annual Report (PBGC, 2002) notes “… we remain exposed to further losses from additional large plan terminations. It may be that PBGC’s current challenges require a policy response to restore the financial strength of the pension insurance system. Accordingly, we are reviewing every option available to ensure that PBGC remains on a fiscally sustainable path.” (p. 3). The PBGC’s takeover of the pension obligations of Bethlehem Steel in December 2002 was viewed as a bellwether action, designed to limit the further accrual of pension liabilities in advance of the company’s bankruptcy.


For example, the 19 firms examined above assumed returns of 8 to 10 percent during the 1990s. Actual returns on the S&P 500 between 1995 and 1999, in contrast, averaged over 25 percent. As a result, the income these firms booked on pension plan returns between 1997 and 1999 was $65 billion less than their actual gains over this period.


In June 2003, the Financial Accounting Standards Board tentatively ruled that companies will be required to disclose on a quarterly basis the amount of their pension plan contributions, details on plan investment returns, and information on pension costs.