As required by P.L.108-18, in May 2003 we began to fund our obligations to the CSRDF based on dynamic assumptions. This increased our biweekly payroll contribution for CSRS employees' retirement from 7.0% of basic pay to 17.4%.

In 2004 we also made the first required annual payment on the "supplemental liability" calculated by OPM. This "supplemental liability" represents the excess of the actuarial present value of future benefits over the actuarial present value of plan assets, future plan contributions, earnings, and other factors.

P.L.108-18 requires that the dynamic funding assumptions include the full value of future benefits related to military or volunteer service when calculating the actuarial present value of future benefits. This provision of P.L.108-18 transfers to us from the U. S. Treasury the responsibility for funding the costs of CSRS benefits that current and former Postal Service employees have earned through military service. P.L.108-18 thus transfers $27 billion in obligations from U.S. taxpayers to our ratepayers.

P.L.108-18 stipulates that the Postal Service shall be allowed to request a reconsideration and review of the OPM computations by the Board of Actuaries of the Civil Service Retirement System. In January 2004, we asked the Board of Actuaries of the Civil Service Retirement System to review the method and computations used by OPM in its calculation of our portion of CSRS benefits because we believe that OPM used an allocation methodology to attribute CSRS pension costs of pre-July 1, 1971, service that assigns an unreasonably large share of the burden to us for payment. The Civil Service Board of Actuaries upheld the OPM methodology in September 2004.

In September 2004, OPM informed us that our first supplemental payment, based on the September 30, 2003 valuation, would be $240 million. We included $125 million of this payment in our 2003 expenses and $115 million in 2004. See note 7 to our Financial Statements for further explanation.

P.L.108-18 identifies as "savings" the difference between the contributions we would have made to the CSRDF had the legislation not been enacted, and the contributions we now make under the law. In 2003 and 2004 we were required to use these "savings" to reduce our debt. In 2003, we calculated our "savings" to be $3.5 billion, and we reduced our debt with the U.S. Treasury by $3.8 billion, thus exceeding the requirements of the law. In 2004, we used "savings" of $2.7 billion to reduce our outstanding debt to the U. S. Treasury, and we reduced our debt by an additional $2.8 billion, for a total debt reduction of $5.5 billion in 2004. We will use the "savings" in 2005 to offset operational expenses and to hold postal rates steady.

Future Use of "Savings"

Congress will consider what to do with the post-2005 "savings" but until Congress acts, any "savings" after 2005 must be placed in escrow. This escrow provision, if not repealed or substantially modified, will significantly impact our financial results and ultimately postage rates. We estimate that without Congressional action, the escrow requirement of P.L.108-18 will require postal rate increases in 2006 to be approximately 5% higher than they otherwise would have been. This will adversely impact the mailing industry, the general public, and ultimately the Postal Service itself, by further exacerbating existing trends of revenue and volume weakness.

As required by P.L.108-18, on September 30, 2003, we submitted two proposals to the President, Congress, and the Government Accountability Office. The first presents our position as to how the "savings" realized after 2005 should be used; the second presents our position that CSRS obligations arising from military service be returned to the U.S. Treasury. In both proposals, we recommend eliminating the escrow requirement and propose using a portion of the "savings" after 2005 to help finance retirement health benefit obligations. The escrowed "savings" requirement of P.L.108-18 will require postal rate increases which negatively affect the mailing industry and the general public. From the standpoint of the postal ratepayer, there can be no "savings" under P.L.108-18 so long as its escrow requirement is in effect.

Our preferred proposal would return responsibility for funding CSRS military service obligations to the U.S. Treasury. Under this proposal, our CSRS pension obligation would be overfunded by $10 billion. This excess CSRS funding would be transferred to a newly established "Postal Service Retiree Health Benefit Fund." We would then fund the "full cost" of retirement health benefit costs on a current basis. Any remaining "savings" would be used to reduce debt.

Our alternate proposal assumes that CSRS military service obligations remain the responsibility of the Postal Service. Under this proposal, we would use the "savings," in a priority sequence, to: first, fund and pre-fund retirement health care benefits; second, repay debt; and third, fund productivity and cost saving capital investments. Beginning in 2006, this proposal would pre-fund retirement health care benefits for all new employees hired in 2003 or later.