Benefit Security Pension Fund Guarantee Schemes

Abstract

The issue of pension benefit security has returned to the foreground of both economic and political debate in many OECD countries - following high profile losses of pension benefits due to plan sponsors becoming bankrupt and leaving underfunded pension schemes. Some countries have dealt with pension benefit protection via strong funding rules (the route taken for example by the Dutch authorities). Two OECD papers examine other methods for increasing benefit security in retirement – via pension benefit guarantee schemes (such as the Pension Protection Fund recently introduced in the UK) and the position of pension creditors within insolvency proceedings (which has been examined, for example, in Canada). Pension Benefit Guarantee Schemes are insurance type arrangements - with premiums paid by pension funds - which take on outstanding obligations which cannot be met by the insolvent plan sponsors. Arguments for such schemes stem from ‘market failure’ (with workers not fully understanding the trade off between pensions – deferred wages – and current income), and diversification– as most workers are highly exposed to the insolvency of the plan sponsor (in terms of current and retirement income) and cannot properly diversify this risk (particularly where the pension is funded by book reserves). However challenges to these schemes exist – mainly in the form of moral hazard and adverse selection – which are problems for all insurance contracts, and potentially in the form of systematic risk (as bankruptcies tend to be correlated, as does pension underfunding across schemes, and indeed as are these two factors). Though setting up benefit guarantee schemes successfully is often a challenge in practice (particularly maintaining true political independence), they can be run successfully - as the funds operating in practice show. Though the problems of the USA guarantee scheme, the PBGC, are well known, similar schemes also exist in Sweden, Germany, Ontario – Canada, Switzerland and Japan and one has recently been launched in the UK. Lessons can be learnt from all these schemes - for example the UK’s PPF is working to apply fully risk adjusted premiums, whilst the Swedish fund can take a lien on plan sponsor’s assets to protect its own financial position. One of the key conclusions from the OECD’s report is that, to work effectively, these schemes must have suitable independence and powers to set and collect appropriately risk-adjusted premiums – but they also need to be considered along with other benefit protection policies (notably effective funding rules).