Employee Retirement Income Security Act Research Articles

An Empirical Analysis of Risk-Related Insurance Premiums for the PBGC

Abstract In 1986, one component of the single-employer plan termination insurance program was altered in an attempt to assure its financial integrity. A year later, the Pension Benefit Guaranty Corporation proposed that the basis for computing premiums for plan sponsors also be changed and the basic philosophy of the proposal was incorporated in the Omnibus Budget Reconciliation Act of 1987. This article develops probability and severity models for large single-employer defined benefit sponsors. Estimates of the liability that underfunded plans impose on the PBGC are obtained from combining the results of the two models and calculations of insurance premiums are presented. Introduction In 1974, the Employee Retirement Income Security Act (ERISA) established a plan termination insurance program for the majority of defined benefit pension plans in the United States to ensure that at least a certain level of participants' benefits would be paid without regard to the funded status or continued existence of the sponsor's pension plan. The extant literature is replete with articles pointing out the preverse financial incentives created by this program (e.g., Sharpe, 1976; Treynor, Regan and Priest, 1976; Treynor, 1977; and Harrison and Sharpe, 1983) and, since its inception, the deficit generated by the single-employer component of this system had grown to as much as $3.8 billion. In 1986, one of the major defects associated with the original design was corrected when the Single Employer Pension Plan Amendments Act (SEPPAA) changed the insured event from that of, in essence, any plan termination to a termination accompanied by a specified event for the plan sponsor. [1] This change effectively limited the insurable event to an insufficient [2] termination due to bankruptcy by the sponsor, thereby virtually eliminating the opportunity of an ongoing sponsor to exchange the unfunded vested liabilities of the plan for 30 percent of its net worth (an option existing under the original provisions of (ERISA). However, it did nothing to change the premium structure from a flat dollar amount per participant. Congress recently redressed this shortcoming in part by enacting a variable rate premium structure that will relate the sponsor's annual premium to the plan's underfunding (as measured on a termination basis). Although this change will factor the plan's potential severity into the determination of the annual premium, it falls short of a risk-related premium structure that would characterize the insurance if it were written in the private sector. Such a structure would base annual premiums not only on the potential severity but also the probability of an insured event taking place (i.e., bankruptcy of a sponsor with an underfunded plan). The new premium system also differs from a free market approach in that it includes a maximum charge of $50 per participant. The idea of risk-related premiums for the plan termination insurance program is not new. In his seminal work on the establishment of a guaranty fund for pension plan benefits insurance, McGill (1970, p. 76) made a provision to reflect the probability of plan termination in the premium rate if the burden appeared to be consequential. Congress, however, initially set the PBGC premium rates at $1.00 per participant. [1] Although PBGC was provided the opportunity under ERISA Section 4006 to modify this initial premium structure, no action was taken until Congress mandated under SEPPAA that PBGC investigate alternative premium bases upon which some or all projected future program costs could be allocated on a variable rated or risk-related computation. In response, the PBGC (1987, p. 55) produced a proposal for a variable rate premium structure that provided the basic structure of the legislative changes under the Omnibus Budget Reconciliation Act of 1987 (OBRA). [4] The new single-employer plan termination insurance program increased the flat rate premium to $16. …

The Liability Nature of Unfunded Pension Obligations since ERISA

The Liability Nature of Unfunded Pension Obligations since ERISA

Payroll Taxes, Social Security, and the Unique Tax Advantage of Company Pensions

Income tax advantages for both employer and employee are widely regarded as nurturing the private pension movement. Increasingly, however, this rationale for pensions has been a matter of dispute, especially since the passage of the Employee Retirement Income Security Act (ERISA) in 1974. The initial concern generated by ERISA was that the new regulatory constraints and administrative requirements would increase the cost of pension benefits negating tax advantages and causing a decline in the use of pensions. (These issues are assessed in Phillips and Fletcher 1976, Scheel 1978, Zock 1979, and Smirlock 1980.) It has also been argued that ERISA eliminated the tax advantage of pensions regardless of its impact on pension costs. Logue (1979) and Tepper (1981), for instance, argue that the net value of the tax advantage from pensions is zero because ERISA provided an alternative for tax-sheltering income intended for retirement saving, the Individual Retirement Account. This view considers only income tax aspects of pensions. The purpose of this paper is to show pensions do confer a valuable and unique tax advantage under a broader consideration of tax advantages encompassing payroll taxes and social security benefits. The debate over pensions as a source of income tax advantages is summarized in Section I. Section II shows that the structure of payroll taxes and social security benefits do make pensions the source of a unique tax advantage. The potential importance of this new way of viewing pension tax advantages is illustrated in Section III by considering its implications for two important aspects of the 1981 Economic Recovery Tax Act and for the problem of social security reform.

The determinants of investment in collectibles: A probit analysis

This study investigates differences that might exist between personality, demographic and financial characteristics of owners and nonowners of collectibles. The merits of an investment in collectibles have often been discussed in business periodicals and popular literature (7, 12, 13). Several factors have contributed to a recent increase in interest in collectibles as an investment. One such influence has been the high rate of inflation in recent years. Another has been the broadening of types of investments considered prudent under the “Prudent Man” rule, which requires fiduciaries to make only those investments which would confirm to the standards of a prudent man. Historically, this rule has been interpreted as precluding investment in assets such as art, antiques, or other collectibles. But recently, because of a number of factors, including regulations issued under the Employee Retirement Income Security Act (ERISA), investments in asset such as collectibles have increasingly been regarding as prudent (9). Academic literature has generally neglected the study of collectibles as investments. An exception is Stein (14) who analyzed paintings as an investment within the context of modern capital market theory. Stein concluded that the investment performance of paintings was similar to that of other investments of comparable risk.

Discussion: Multiperiod Pension Plans and ERISA

Protection of pensions is a most important subject. The date that the Employee Retirement Income Security Act (ERISA) was signed, September 2, 1974, is considered the second most important date in social legislation in the United States--second only to the enactment of Social Security.

Multiperiod Pension Plans and ERISA

Corporate pension plans represent a large and growing force in the capital market. Their promised benefits comprise a large portion of the expected retirement income of millions of employees. Because of this importance, and because of some widely publicized abuses and scandals, these plans were the subject of increased governmental regulation in the 1970s. One outgrowth of this has been the Employee Retirement Income Security Act (ERISA) under which the Pension Benefit Guarantee Corporation (PBGC) provides insurance of pension benefits. The objective of this paper is to develop a multiperiod model of the pension plan in order (1) to evaluate the robustness of prior analyses of the wealth transfers caused by the passage of ERISA among workers, firms, and the PBGC; (2) to characterize the nature of a PBGC insurance scheme which could, if it were so desired, reduce the potential liability of the PBGC; and (3) to serve as a prototype for modeling the multiperiod pension plan.

Pension Plans and the Writing of Fully-Covered Exchange Traded Call Options

A question facing pension managers is whether fully-covered call option writing strategies should be pursued. This study is designed to provide an answer by comparing the risk and returns of two buy-and-hold option portfolios to those of the underlying stocks and the market as a whole for May 1973 through April 1977. The conclusions are: I ) covered call options reduce the risk of equity portfolios, 2) no evidence supports the belief that a learning period favorable to option writing existed during the early years of CBOE existence, and 3) options are most likely to improve the risk-adjusted returns of equity portfolios when overall market prices are declining. With the passage of the Employee Retirement Income Security Act (ERISA) of 1974, investment managers and other fiduciaries of pension funds found themselves subject to vague, but potentially strict standards of conduct. Among other requirements, ERISA provides that individuals in charge of pension assets must act the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims [29 U.S.C.A., sec. 404(a) (1974)]. Because of this requirement, some investment managers suggested that exchange-traded call options on some or all the common stocks in pension portfolios be written in order to derive additional income from the stock portfolio while obtaining some protection against stock price declines. Rather than causing insurers and trust departments to rush to the options market to write call options for their pension business, ERISA's prudence requirement usually has been cited as a major reason for ignoring options. Some of the specific fears have been: the absence of complete regulatory acceptance, the expenses associated with managing option portfolios, conSandra G. Gustavson is Assistant Professor of Finance in the College of Commerce and Business Administration, University of Illinois at Urbana-Champaign, where she specializes in risk and insurance. She holds the Ph.D. degree and has completed several examinations administered by the Society of Actuaries. The author thanks Sophie H. Chang, Doris Gustavson, and Kathleen A. Levy for their assistance in collecting and analyzing the data. The author also is indebted to Robert I. Mehr, Frank K. Reilly, and three anonymous referees of The Journatil of Risk andbl Insurance for their helpful suggestions. This research was financially supported in part by the Research Board of the Graduate College, University of Illinois at Urbana-Champaign, and by the Department of Finance, College of Commerce and Business Administration, University of Illinois at Urbana-Champaign. Thanks are due both these academic units.

Optimal Selection of Passive Portfolios

In the last few years, the use of as one part of a total investment strategy has gained acceptance among investors, particularly among corporate pension sponsors. Use has been spurred partly by the passage in 1974 of the Employee Retirement Income Security Act (ERISA), which caused many pension sponsors to re-evaluate the management of their pension portfolios.* Index funds are appealing both on economic and fiduciary grounds, because typically they have lower management fees and higher diversification than managed portfolios. This has led to considerable growth in indexed pension assets, as is demonstrated by the figures in Exhibit 1. The majority of these assets are managed by external money managers, but there is a distinct trend for corporations to manage a proportion of their pension assets in an in-house index fund. This trend is also true for public funds, as evidenced by the recent formation of a $500 million index fund run by the New York State Common Retirement Fund [5]. An index fund is a passive (as opposed to active) portfolio that is designed to track closely a visi-