Pension insurance schemes and moral hazard: The Pension Benefit Guaranty Corporation should restrict the insured pension plans’ portfolio policy

Abstract

The pension insurance schemes existence leads to moral hazard: the insured defined benefit pension plans tend to invest more heavily in risky assets. A possible countermeasure mentioned in the literature, but not yet analyzed, is the introduction of a restriction on the pension plans’ portfolio policy. The US context is chosen for analysis. We argue that a portfolio restriction is needed in the case of a sponsoring firm in financial difficulty having an underfunded pension plan. We prove that the restriction should respond to the objective of liability hedging. Estimation results suggest that the corresponding portfolio strategy is a low-risk policy. The paper recommends that the maximum equity proportion is fixed at 30%.