The UK Approach to Insuring Defined Benefit Pension Plans

Abstract

AbstractThis chapter models the UK’s recently-established Pension Protection Fund (PPF) established to guarantee defined benefit pensions. It shows that the PPF is likely to face many years of low claims interspersed irregularly with periods of very large claims. There is a significant chance that these claims will be so large that the PPF will default on its liabilities, leaving the government with no option but to bail it out. This is because of the double impact of a fall in equity prices on the PPF, which would render sponsor firms more likely to default and make defaulted plans more likely to be underfunded. The chapter derives a fair premium for this insurance under different circumstances, estimates the extent of cross-subsidies in the PPF between strong and weak sponsors, and shows that risk rated premiums are unlikely to have a substantial effect on either the size or the lumpiness of claims unless they are so powerful that they force weaker sponsors to cut fund deficits and improve the match between assets and liabilities.