Under the new pension insurance paradigm outlined by former PBGC chief economistRichard Ippolito pensionplan sponsors are held jointly liable for any deficit that develops. In effect, the new plan would set premiums each period proportional to the average probability of bankruptcy in a period , according to the Cato Institute’s “How to Reduce the Cost of Federal Pension Insurance.” Thus, ” the overall premium rate, however, can increase or decrease as the overall risk of bankruptcy across all insureds increases or decreases.”
Further, the new plan would set up “an immediate incentive” for plan sponsors to fully fund their plans, and thus reduce their insurance premium. For example, by fully funding a defined benefit plan with duration-matched bonds, the premium would be zero. Whereas, “plans that wanted to expose the pool to lots of risk would be required to pay commensurately higher premiums,” the Cato Institute’s report said.
The report though does not suggest a total fixed-income allocation to alleviate higher premium payments. For those plans that will have at least partial funding in stocks, Ippolito says they could “dramatically reduce their premiums if they held assets that exceeded liabilities so as to create a cushion against reductions in stock value.”
The new system overall would create a system in which “sponsors of underfunded plans will then have an interest in reducing their reliance on payments from well-funded plans so as to keep them as a source of some help in solving the underfunding problem,” Ippolito says.
Without such a drastic change, the report warns the PBGC’s deficit will only continue to grow, a scenario that may ultimately require taxpayer assistance to remedy. “As long as sponsors of underfunded pension plans are not held responsible for the exposure they impose on the PBGC, ultimately either the premium level must increase, in which case some of the cost will be shifted to well-funded pensions in the short run, or, if exposures create claims that reach catastrophic levels, taxpayers will be called upon to provide a bailout through the PBGC,” says Ippolito.
“Once taxpayers were removed as ultimate guarantors of the insurance, the plans themselves would have an incentive to align premiums with exposure, and plan sponsors would have to face up to the problems that their own underfunding creates,” Ippolito concludes.
The full study is available at http://www.cato.org/pubs/pas/pa-523es.html .