Pension Benefit Guaranty Corporation Research Articles

Risk Shifting in Pension Investment

This paper provides evidence that pension regulations can incentivize or curb risk shifting in the investment of defined benefit (DB) plan assets. We document that in the U.S., whereby the pension insurance premium charged by the Pension Benefit Guaranty Corporation (PBGC) is largely flat, financially distressed firms with severely underfunded plans shift pension investment risk. We further find that risk shifting is mitigated in the U.K. after the implementation of risk-adjusted pension insurance premium, and in the Netherlands where full pension funding is mandatory. Overall the results in this paper lend support to the view that structural flaws in the U.S. statutory pension insurance scheme incentivize high-risk sponsors to gamble their pension assets when distress terminations of their plans become foreseeable.

Growth Opportunities, Stockholders' Claim/Liability on Pension Plans, and Corporate Pension Policies

In this study, I derive the value of stockholders' claim on a pension surplus and stockholders' liability for a pension deficit in the post‐Employee Retirement Income Security Act regulatory environment. Based on that valuation, I develop a model of corporate pension policies in which sponsoring firms weigh contributions to their pension plan against the exercise of growth options in the allocation of limited financial resources. The model shows how corporate pension funding and asset allocation policies are shaped by the sponsoring firms' characteristics, such as growth options, the marginal corporate tax rate, and regulatory variables such as the deficit reduction contribution rate, the variable‐rate insurance premium, and the maximum possible fraction of operating assets that can be seized by the Pension Benefit Guaranty Corporation. I discuss policy and empirical implications of the theoretical results. Copyright © 2016 John Wiley & Sons, Ltd.

The Effect of Regulations on Pension Risk Shifting: Evidence from the US and Europe

AbstractThis paper provides evidence that pension regulations can incentivize or curb risk shifting in the investment of defined benefit plan assets. We document that in the US, where the pension insurance premium charged by the Pension Benefit Guaranty Corporation is largely flat, financially distressed firms with severely underfunded plans shift pension investment risk. We further find that risk shifting is mitigated in the UK after the implementation of risk‐adjusted pension insurance premiums, and in the Netherlands where full pension funding is mandatory. Overall the results in this paper lend support to the view that structural flaws in the US statutory pension insurance scheme incentivize high‐risk sponsors to gamble their pension assets when distress terminations of their plans become foreseeable.

The PBGC Wins a Case When the Debtor Keeps its Pension Plan

The Pension Benefit Guaranty Corporation, the federal agency charged with insuring private-sector defined benefit pension plans, has long had a prominent role in corporate bankruptcies. PBGC focuses its effort on the continuation of pension plans, in true reorganizations and in sales of businesses. To this end, ERISA has made it more difficult for a sponsor to terminate a plan in its own economic interest. For example, a sponsor's latitude to terminate an underfunded plan was limited to circumstances involving the sponsor's financial distress. Likewise, the termination premium, which was added to ERISA in recent years, is an obligation that survives bankruptcy and it may help to deter some unwarranted terminations. Unfortunately, in some cases, PBGC must seek plan termination, and PBGC then seeks to maximize its recoveries. These are blunt tools, however, and the case law has further dulled them. With plan continuation the preferred outcome, PBGC succeeds in its statutory mission whenever a sponsor emerges from bankruptcy with its pension plan ongoing.

Long Term Passive Investment Strategies as a Part of Pension Systems

(ProQuest: ... denotes formulae omitted.)IntroductionThe effectiveness of long term investing has been a main topic of various theoretical as well as practical studies. A lot of academicians and financial professionals are supporters of passive investment strategies such as buy & hold or indexing. On other hand there are some studies that show that there are some active investment strategies based on stock picking or market timing, that are able to record superior results.Malkiel (2012) and Bogle (2010) came to conclusion that index investing is as effective as active managed funds in long term. It was proven that on a 16-year time horizon, index funds achieve same results as actively managed funds. These findings have been supported also by other publications. For example Siegel (2014) analysed whole history of U.S. share market and he came to conclusion that passive investment strategies are efficient despite some market collapses, but a long time horizon is needed. A similar conclusion was reached by Graham (2007, 2008).Most of authors support buy & hold strategy, although many of them claim that it should be supported by cost averaging effect. The cost averaging effect limits negative effects of market crashes. The investor buys stocks on a regular basis, regardless market development. If stock market collapses, investor buys stocks at lower prices which results in a lower average purchase cost. Positive results of long term investing using cost averaging effect were presented also by study of Edelson (2007).A detailed analysis of selected long term stock market investment strategies as well as comparison of passive and active investment strategies was conducted also by other authors. For example Pastor and Stambaugh (2012) focused on declining effectiveness of actively managed investment funds. French (2008) came to conclusion that the typical investor would increase his average annual return by 67 basis points over 1980-2006 period if he switched to a passive market Lye (2012) analysed differences between growth and value stocks. Cambell, Polk and Vuolteenaho (2010) analysed systematic risks of stock investing.One of newest contributions to discussion was presented by Fabozzi (2015) who analysed current state of U.S. Pension Benefit Guaranty Corporation (PBGC). He concluded that some changes in investment strategies of funds should be made. He also advises that PBGC should introduce a benchmark for pension fund investments.Some arguments in favour of passive investment strategies were presented by Wingenfeld (2013) who talks about five specific qualitative arguments that are eligible to be a theoretical proponent for passive portfolio management. This topic is in centre of attention of some of Chinese economists as well. For example Wang, Beland and Zhang (2014, 2014) warn that there is a pension system missing in China. It could become a huge problem due to rapidly aging Chinese population.1. MethodologyIn this paper, effects of long term investing over a 30-year time period are analysed. This time horizon enables inclusion of one of European share markets into analysis, as European share indices didn't exist before 80's. The 30-year time horizon is also a usual time of involvement of an individual in a pension scheme.The effects of long term saving and investing on time horizon of last 30 years are examined. The American S&P 500 stock index is used, as American stock market is most liquid one, with a well-documented history. It consists of various share companies across all of sectors of U.S. economy. It also reflects relation between U.S. share market and U.S. economy very well. It is very close to theoretical concept of optimal portfolio. The long term investing in S&P 500 will be compared to long term investing of risk-free short-term securities. …

Federal Agencies in the Legislative Process: Technical Assistance in Statutory Drafting

Federal agencies draft statutes. Indeed, they are often the chief architects of the statutes they administer. Even when federal agencies are not the primary substantive authors, they routinely respond to congressional requests to provide technical assistance in statutory drafting. Yet despite their substantial role in the legislative process, our understanding about how agencies interact with Congress is greatly undertheorized and perhaps even less understood empirically. This Report, which was commissioned by the Administrative Conference of the United States (ACUS), explores the latter role of federal agencies in the legislative process: the provision of technical assistance in statutory drafting.To better understand the technical drafting assistance process, the Author met with agency officials at some twenty executive departments and independent agencies for a total of over sixty hours of interviews. Ten of these agencies agreed to participate on the record: the Departments of Agriculture, Commerce, Homeland Security, Education, Energy, Health and Human Services, Housing and Urban Development, and Labor as well as the Federal Reserve and the Pension Benefit Guaranty Corporation. Subsequent to the interviews, the participating agencies responded to an anonymous, forty-question follow-up survey. The Report presents the key findings from this study, identifies the best practices that certain agencies have developed to address these challenges, and proposes recommendations for ACUS to consider. These recommendations focus both on internal agency practices to improve the technical drafting assistance process and external practices to strengthen agencies’ relationship with Congress in the legislative process.

Evaluating Pension Insurance Pricing

The Pension Benefit Guaranty Corporation (PBGC)’s Pension Insurance Modeling System (PIMS) model has taken on the Herculean task of modeling in detail and under many scenarios the cash outflows associated with the pension obligations they have assumed. This paper’s comments are focused almost entirely upon PBGC’s termination liabilities, and address four pressing issues: (1) the need to discount the liability stream by current riskless interest rates instead of using corporate bond rates that reflect credit risk, call risk, and other risks, or using some ad hoc prescribed average of past rates; (2) the need to use a term structure of interest rates; (3) the need to employ more useful investment management benchmarks; and (4) how to implement a relevant and rigorous liability benchmark.

Joint risk of DB pension underfunding and sponsor termination: incorporating option-based projections and valuations into PIMS

AbstractWhen a private pension plan sponsor with an underfunded plan becomes insolvent, the difference between the value of the plan's assets and its termination liabilities represents a liability for the Pension Benefit Guaranty Corporation (PBGC). Hence, accurately modeling the joint statistical distribution over time of defined benefit pension underfunding and sponsor terminations is critical for estimating PBGC's prospective cash flows and evaluating its financial position. It appears that the current Pension Insurance Modeling System (PIMS) approach to modeling risk does a reasonable job of capturing its statistical properties effects on PBGC cash flows, although some of the aspects might be improved, and metrics expanded. The present paper outlines, how an option-based approach to modeling the joint distribution of defaults and underfunding in PIMS might be implemented, while preserving the strengths of the current model. Moving to an option-based approach would allow PIMS to be used to estimate the fair values of future liabilities. Such an approach could have a significant effect on the perceived financial position of PBGC.

Financial market assumptions and pension plan models: a comment on PIMS model asset markets assumptions

AbstractThe financial market assumptions of the Pension Benefit Guaranty Corporation (PBGC)'s Pension Insurance Modeling System model are critical inputs to simulations for most apparent uses of the system. They currently appear to be based on a reduced form, ‘classical’ approach to assessing and forecasting the distribution of returns on various classes of input assets, allowing for a fairly sophisticated and useful approach to understanding simulated distributions of potential pension insurance outcomes as well as the net financial status of the PBGC. This technical note discusses some of the capital market side assumptions utilized in the model. It also comments on important related assumptions including the assumed asset allocations of insured plans, making suggestion for possible modification of input assumptions of the model to reflect time variation in financial market return behavior as well as time variation in observed plan allocations.

Evaluating pension insurance pricing

AbstractThe Pension Benefit Guaranty Corporation's (PBGC) Pension Insurance Modeling System model has taken on the Herculean task of modeling in detail and under many scenarios the cash outflows associated with the pension obligations, they have assumed. This paper's comments are focused almost entirely upon the PBGC's termination liabilities, and address four pressing issues: (1) the need to discount the liability stream by current riskless interest rates instead of using corporate bond rates that reflect credit risk, call risk, and other risks, or using some ad hoc prescribed average of past rates; (2) the need to use a term structure of interest rates; (3) the need to employ more useful investment management benchmarks; and (4) how to implement a relevant and rigorous liability benchmark.

Economic and financial approaches to valuing pension liabilities

AbstractFinancial economics holds that payment streams should be valued using discount rates that reflect the cash flows’ risks. In the case of pension liabilities, the appropriate discount rate for a pension fund's liabilities is the expected rate of return on a portfolio that would be held under a liability-driven investment policy. The valuation of defined benefit pension obligations involves choices revolving around deciding: (1) what future benefit payments to recognize today (i.e., which liability concept to use); and (2) from whose point of view to value the liabilities. Moving towards modeling, the distribution of future liabilities using a ‘risk-neutral’ framework, would allow for calculating the present value of the future liabilities more accurately. This would provide policymakers with information more relevant for the decision-making, and it would also permit easier communication of the risks facing the Pension Benefit Guaranty Corporation's PIMS model via a single univariate statistic.

Measuring and explaining pension system risk

AbstractWe discuss pension system risk in the USA, focusing on the investment policy and the methodology for the valuation of the liabilities of the Pension Benefit Guaranty Corporation (PBGC). We offer suggestions as to how the PBGC should consider modifying the Pension Insurance Modeling System. The issues of investment policy and liability valuation are not two distinct topics. As emphasized here, the proper valuation of liabilities provides a benchmark for the PBGC to use as a starting point for the establishment of its investment policy and then for assessing investment performance.

Multiemployer Pension Plans, the PBGC, and the MPRA

Multiemployer pension plans are negotiated between a union and two or more (usually many) employers in an industry. There are over 1,400 of them covering 10.4 million participants and they are insured by the Pension Benefit Guaranty Corporation (PBGC). In the aggregate, they are now woefully underfunded, as is the PBGC’s Multiemployer Program. Congress has enacted several laws in an effort to strengthen the financial position of multiemployer plans and to protect the PBGC. The most recent is the Multiemployer Pension Protection Act of (December) 2014 (MPRA). One of the tenets of pension law has been that retirement benefits once accrued and vested are inviolable. They cannot be curtailed or rescinded. The MPRA allows the trustees of certain distressed multiemployer plans to reduce the benefits of active and inactive participants including retirees in pay status. This paper examines the developments leading up to the MPRA and the underlying problems of multiemployer pension plans and the PBGC.

The Plight of the Pension Benefit Guaranty Corporation

The Pension Benefit Guaranty Corporation (PBGC) was created by the Employee Retirement Income Security Act of 1974 to insure the vested benefits of defined benefit pension plans. Over the past 40 years its funding requirements and insurance premiums have been strengthened and increased many times, most recently by the Multiemployer Pension Reform Act of (December) 2014. Yet the PBGC remains in difficult straights. The plight of the PBGC is that, whatever it does to improve its short-run prospects will result in more plan failures and terminations in the long run.

Overviewing the findings: the Technical Panel Review of the Pension Insurance Modeling System

AbstractThe Pension Benefit Guaranty Corporation's (PBGC) Pension Insurance Modeling System (PIMS) is used to evaluate the financial security and resilience of the national program backstopping private defined benefit plans. The Pension Research Council of the Wharton School at the University of Pennsylvania recently convened a Technical Review Panel of experts to review key inputs, outputs, and model assumptions. Our review was intended to provide a formal evaluation of the technical adequacy of the model by outside experts. The papers herein summarize views of each expert on this project. Key findings are as follows: •The PIMS models are an important and valuable tool in modeling the Pension Benefit Guaranty Corporation's liability risk. To the best of our knowledge, there is no other model that can do a comparable job.•Nevertheless, some improvements could be integrated in the Agency's approach to modeling. Those deserving highest priority attention, in the experts’ view, include incorporating systematic mortality risk (i.e., treat mortality and longevity as stochastic variables); including new asset classes increasingly found in defined benefit plan portfolios (e.g., commercial real estate, private equity funds, infrastructure, hedge funds, and others); developing a more complex model for the term structure of interest rates; and incorporating an option value approach to pricing the insurance provided.•The Agency could also do more to communicate the range of uncertainty and potential for problems associated with the PBGC's financial status. This could include additional information including the conditional value-at-risk, and perhaps an ‘intermediate,’ ‘optimistic’, and ‘pessimistic’ set of projected outcomes, as well as the expected ‘date of exhaustion’ for assets backing pension benefits insured by the PBGC.

Integrated risk management for defined benefit pensions: models and metrics

AbstractThe Pension Benefit Guaranty Corporation (PBGC) insures private sector defined benefit (DB) pension plans, when an employer becomes insolvent and is unable to pay the pension liabilities. In principle, the insurance premiums collected by PBGC should be sufficient to cover potential losses; this would ensure that PBGC could pay the insured benefits of terminated pension plan without additional external funding (e.g., from taxpayers). Therefore, the risk exposure of the PBGC from insuring DB pension plans arises from the probability of the employer insolvencies; and the terminating plans’ funding status (the excess of the value of the insured plan liabilities over the plan assets). Here we explore only the second component, namely the impact of plan underfunding for the operation of the PBGC. When a DB plan is fully funded, the PBGC's risk exposure for an ongoing plan is low even if the plan sponsor becomes insolvent. Thus the questions most pertinent to the PBGC are: what key risk factors can produce underfunding in a DB plan, and how can these risk factors be quantified? We discuss the key risk factors that produce DB pension underfunding, namely, investment risk and liability risk. These are interrelated and must be considered simultaneously in order to quantify the risk exposure of a DB pension plan. We propose that an integrated risk management model (an Integrated Asset/Liability Model) can help better understand DB pension plan funding risk. We also examine the Pension Insurance Modeling System developed by the PBGC in terms of its own use of some of the building blocks of an integrated risk management model.

De-Risking Pension Plans Revisited

The Pension Protection Act of 2006 changed the way in which the value of lump sum distributions is calculated. When the new method was fully implemented in 2012, it triggered a flood of de-risking activity by sponsors of defined benefit pension plans via one-time lump sum distributions, group annuity contracts with insurance companies and liability driven investing. Underlying these developments were a number of economic and demographic factors including a rising equity market, low interest rates, increased Pension Benefit Guaranty Corporation insurance premiums and a declining number of active participants. These forces are still there. Indeed, they have strengthened due to recent legislation (MAP-21 in 2012, BBA in 2013 and HATFA in 2014). In addition, a number of legal questions have been resolved by the Verizon Communications decision of 2014 and new mortality tables have just been published by the Society of Actuaries. The combination of these developments indicate that 2015 will be another big year for pension plan sponsors to transfer pension risk to participants through lump sum distributions and to insurance companies through group annuity contracts.

What Should Be Done About the Underfunding of Defined Benefit Pension Schemes? A Case Study of Ireland

Defined Benefit (DB) pension schemes have prevalence in certain countries, most notably the UK. This is also the case for Ireland. Underfunding of DB pension schemes is prevalent throughout the Western world, and no more so than Ireland. This paper examines underfunding of DB schemes in Ireland and discusses alternative ways of overcoming this problem. It critically reviews alternative government sponsored insurance schemes including the US Pension Benefit Guaranty Corporation (PBGC) and the UK Pension Protection Fund (PPF), underpinned by the introduction of risk-based levies. Commentators have suggested introducing some variant of the latter scheme in Ireland. The paper also examines alternative schemes that have been proposed to understand the dynamics of the level of underfunding and how this can be addressed. Finally it examines the risks inherent in DB schemes and details how these will affect the introduction of any mechanism that tries to address the levels of underfunding in Ireland.

Technical Review Panel for the Pension Insurance Modeling System (PIMS)

In April of 2013, the Pension Research Council of the Wharton School at the University of Pennsylvania convened a Technical Review Panel, comprising ten experts whose task it was to review the Pension Benefit Guaranty Corporation’s (PBGC) Pension Insurance Modeling System (PIMS), including inputs, outputs, and model assumptions. The review was intended to provide a formal evaluation of the technical adequacy of the model by outside experts. Each expert participating on the Technical Panel was asked to review background material (see References) and focus on a particular aspect of the PIMS model. The list of panelists and topics was developed by the Council in discussion with the Social Security Administration (SSA). This report and the appended papers herein from our Technical Panel comprise the Final Report under this project. The Panel’s key findings may be summarized as follows: (1) The PIMS models are an important and valuable tool in modeling the Agency’s liability risk. To the best of our knowledge, there is no other model that can do a comparable job; (2) Nevertheless, some improvements could be integrated in the Agency’s approach to modeling. Those deserving highest priority attention in the experts’ view are the following: (a) Incorporating systematic mortality risk (i.e., treat mortality and longevity as stochastic variables); (b) Including new asset classes increasingly found in defined benefit plan portfolios (e.g., commercial real estate, private equity funds, infrastructure, hedge funds, and others); (c) Developing a more complex model for the term structure of interest rates; and (d) Incorporating an option value approach to pricing the insurance provided. (3) The Agency could also do more to communicate the range of uncertainty and potential for problems associated with the PBGC’s financial status. This could include additional information including the Conditional Value at Risk (CVaR), and perhaps an ‘intermediate,’ ‘optimistic,’ and ‘pessimistic’ set of projected outcomes, as well as the expected ‘date of exhaustion’ for assets backing pension benefits insured by the PBGC.

Introduction

Introduction