Policy Analysis No. 523

How to Reduce the Cost of Federal Pension Insurance

By Richard Ippolito
August 24, 2004

Executive Summary

The Pension Benefit Guaranty Corporation, the federal agency that insures private-sector defined-benefit pension plans, had a surplus of $9.7 billion at the end of 2000 but a deficit of $11.2 billion at the end of 2003. Pension plan underfunding stands at more than $350 billion, which increases the likelihood that more pension plans will go under and taxpayers will eventually be called upon to provide a bailout.

The reasons for the PBGC’s financial difficulties can be found in the structure of defined-benefit pension plans and in the way Congress set up the premium rules when it created the program in 1974. First, because the PBGC stands as the ultimate guarantor of companies’ pension liabilities, plan sponsors have an incentive to invest their assets in equities rather than fixed-income securities of the same duration as the liabilities. Second, funding rules allow companies to make gradual contributions to their pension plans in the event of underfunding, which guarantees long-term exposure for the PBGC. Furthermore, when faced with higher contributions, companies have usually appealed to Congress to reduce the underfunding that they need to report, which reduces contribution requirements.

Unfortunately, Congress has failed to adequately address the problems of the PBGC. In temporary legislation passed in April 2004, Congress reduced the required contributions companies must make to their defined-benefit pension plans by an estimated $80 billion over two years by changing the formula used to calculate pension liabilities. Congress also provided additional relief of approximately $1.6 billion to steel and airline companies with heavily underfunded pension plans.

Rather than place the PBGC on sounder financial footing, those measures will likely worsen the agency’s financial condition. For that reason—and to reduce the likelihood that taxpayers will have to bail out the PBGC—when Congress revisits this issue in two years’ time, it should adopt legislation that contains the following provisions: First, it should enforce the current premium rules so that companies do not avoid paying premiums to the PBGC if their plans are underfunded. Second, it should modify those rules so that premiums are truly risk based. Finally, Congress should allow pension insurance to be offered independent of the PBGC in the private sector or through a selfinsurance pool whose members would be jointly responsible for any deficits their plans created.

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Richard A. Ippolito is the former chief economist at the Pension Benefit Guaranty Corporation.