Arnold Kling  

Pension Guarantee Hazards

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A Wall Street Journal editorial notes,


Congress and the White House produced a big, fat bailout for the most financially shaky companies, and some of those same companies are now joining the queue to dump their liabilities on the feds. Meanwhile, PBGC's [Pension Benefit Guaranty Corporation] deficit was left to balloon, as it now has -- by $12 billion with 155 company plans terminating.

...One popular solution is to raise the premiums paid by companies -- which haven't been increased since 1994 -- along with adjusting those premiums for risk. But a premium increase would make it more likely that healthy companies will drop out of the system, and risk-adjusted premiums give those financially fragile companies a strong incentive to terminate their plans.

The big problem is that the agency, by insuring private pension plans, has created its own moral hazard. Essentially, PBGC is writing a put option for which any private plan that is not fully funded is in-the-money; therefore, exercising the put by dumping liabilities onto the PBGC is attractive. Ultimately, of course, the put is written by taxpayers to the tune of tens of billions of dollars.


A friend who once did consulting for the PBGC says that its policies are completely irrational. It tells companies with overfunded pension plans that they can take every dollar of overfunding out the plans, and it tells companies with underfunded plans that it will bail them out. There is no risk-based pricing or other incentive mechanism to make companies want to maintain sound plans. He says that it makes the pre-S&L-crisis FSLIC seem well-run by comparison.

UPDATE: Bruce Bartlett emailed me with a link to coffi.org, which has a lot of useful stuff on the PBGC.

For Discussion. Any insurance involves writing a put option. How can the PBGC avoid giving out a free put option?


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TRACKBACKS (1 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/159
The author at A Stitch in Haste in a related article titled PBGC Foreshadows Social Security Crisis writes:
    The specific numbers at the PBGC aren't so important as the bureaucratic behavior in the face of the crisis and what it portends for Social Security as time passes and the crisis deepens. UPDATE: Arnold Kling takes it up a notch. [Tracked on November 22, 2004 9:39 AM]
COMMENTS (5 to date)
rvman writes:

Requiring that all stockholder equity and company assets be liquidated before insurance pays out springs immediately to mind. The insurance is to protect the pensioner, not the company. Same should be true of a bank - if the bank continues after the bailout, it should be because rights to the name alone were sold to benefit the depositers. It may be more expensive short run to do it this way, but in the long run it avoids a lot of incentive hassles. Legally prioritizing pensions and depositers before other creditors would force those creditors to examine pension liabilities when extending credit, which may put pressure on the company to fund and manage prudently.

Lawrance George Lux writes:

The real elimination of the 'put option' is garnishment of all Labor and Management(including Dividends) salaries and Benefit packages until all loses are recovered. lgl

Robert writes:

Privatize it

Jason Ligon writes:

"Privatize it"

Agreed. Keep the funding requirements in place as a matter of law. Eliminate the PBGC, and simply require as a matter of contract law that each company meets its defined benefit agreements. Corporate assets and wages should be on the line to cover any shortfalls.

Would this have the impact of making defined benefit plans even less desirable than they are now? Likely so, but what we have now is the illusion of a free lunch. I'd rather see defined contributions into annuity programs as a way to get retirement income, which places the risk where it belongs.

Taylor writes:

In a rather obscure way this reminds me of the hockey strike currently beseiging the the NHL. The player's union wants guaranteed higher salaries, but the market can't handle it. More than 2/3 of the teams are losing money, some are losing less by not playing at all.

It seems strange to me that the players (and in this case the policy makers at Congress), can't comprehend the mechanics of our economic system. I have had but brief education (introduction to micro and macro) and the answer of privitization seems to obvious to me that only the obtuse would not come to a similar conslusion.

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