The PBGC Premium and the Pension Plan's Risk-Taking: Should the PBGC Take the PPF As an Example?
21 Pages Posted: 14 Feb 2018
Date Written: February 1, 2018
This paper focuses on the way the PBGC premiums should be defined. In the current debate, a better risk adjustment is sought, and the PPF is given as an example. The paper analyzes the effect the PBGC premium form has on the sponsoring firm's risk-taking in its pension plan. We show that risk-taking increases (decreases) when the actual bankruptcy probability of the firm is higher (lower) than the proportion of underfunding taken into account in the premium. Numerical results suggest that if the PBGC increased the current underfunding proportion, risk-taking would be reduced, albeit slightly. The paper's conclusion is that adopting risk-adjusted premiums of the PPF-type is an advisable measure for the PBGC. The effect of the insurance contract on risk-taking would be then eliminated. However, whatever the premium form, the problem of firms in financial trouble will remain unsolved, and other measures than risk-adjusted premiums are needed to prevent their risk-seeking behavior.
Keywords: pension insurance; premium; risk adjustment; moral hazard; risk-taking; PBGC; PPF
JEL Classification: G22; G23; G28
Suggested Citation: Suggested Citation