A Private Market Pension Insurance System?

September 26, 2007 (PLANSPONSOR.COM) - A new research paper argues that the post-Pension Protection Act (PPA) Pension Benefit Guaranty Corporation (PBGC) still needs fixing including the possible conversion to a private pension insurance model.

The study focusing on the nation’s private-sector pension insurer by Jeffrey R. Brown, a finance professor at the University of Illinois at Urbana-Champaign and prepared for the National Bureau Of Economic Research, also suggests federal lawmakers could further tighten pension laws and rules.

Such additional legislative action could restrict pension portfolios to ensure better asset/liability matching, according to the study, “Guaranteed Trouble: The Economic Effects Of The Pension Benefit Guaranty Corporation.”

“While the Pension Benefit Guaranty Corporation has protected thousands of workers and retirees who might have otherwise experienced devastating losses to their pensions after their employer declared bankruptcy, it has also created perverse economic incentives due to the program’s failure to price the insurance according to economic principles, its failure to provide adequate funding incentives, and its failure to disclose important information to market participants,” Brown asserts. “Recent legislation has improved the program rules, but the reforms did not eliminate the structural problems facing the PBGC.”

Concludes Brown: “Together, these three flaws produced a system in which many firms fail to adequately fund their pension obligations, knowing that in financial distress, they can dump their pension liabilities onto the PBGC.”

High-Risk versus Low-Risk Plans

The professor also charges that the PBGC premium schedule also fails to differentiate between high- and low-risk pension plan sponsors – that is, its insurance premiums are not linked to firm creditworthiness.

“Even if Congress were to grant such powers to the PBGC, which seems unlikely, there are reasons to be concerned about how well it would be executed, especially in a political environment,” he writes. “While most of the provisions of the Pension Protection Act of 2006 were steps in the right direction, at least one set of provisions constituted a giant leap backwards – the special rules for airlines (See   Legislation To Partly Renege Pension Funding Break ).”

Moving the nation’s defined benefit system to the private insurance market would have the benefit of having private insurers risk-adjust their premiums charged to plan sponsors.

However, Brown points out that a number of academic studies have tried to calculate how much the private pension insurance market would cost with one such undertaking estimating expenses of twice what the PBGC currently charges. Other studies have suggested four to six times the level of premiums might be seen in a private insurance market system.

Brown readily acknowledges that such a development would not be met with universal open arms. “Replacing the PBGC with mandatory private insurance would be criticized by those who believe that the PBGC should be viewed as a social insurance program with intentional subsidies to the defined benefit system, rather than as a standard insurance contract,” he asserted.

The paper can be ordered   here .