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A risk-based premium: What does it mean for DB plan sponsors?

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  • Chen, An
  • Uzelac, Filip
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    Abstract

    This paper develops a risked-based premium calculation model for the insurance provided by the Pension Benefit Guaranty Corporation (PBGC). It takes account of the pension fund’s and the plan sponsor’s investment policy and extends Chen (2011) by considering distress termination triggered by the sponsor’s underfunding. We empirically illustrate our theoretical pricing formula for the 100 biggest American DB sponsoring companies. Our result clearly casts doubt on the current practice where about 70% of the PBGC premiums charged are flat. We observe that the funding ratio and the leverage are the main risk factors in a risk-based premium calculation.

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    Bibliographic Info

    Article provided by Elsevier in its journal Insurance: Mathematics and Economics.

    Volume (Year): 54 (2014)
    Issue (Month): C ()
    Pages: 1-11

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    Handle: RePEc:eee:insuma:v:54:y:2014:i:c:p:1-11

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    Web page: http://www.elsevier.com/locate/inca/505554

    Related research

    Keywords: PBGC; Defined benefit plan; Distress termination; Correlation; Sponsor support;

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    References

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    1. Treynor, Jack L, 1977. "The Principles of Corporate Pension Finance," Journal of Finance, American Finance Association, vol. 32(2), pages 627-38, May.
    2. Zvi Bodie, 2006. "On asset-liability matching and federal deposit and pension insurance," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 323-330.
    3. Alan Marcus, 1987. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Chapters, in: Issues in Pension Economics, pages 49-80 National Bureau of Economic Research, Inc.
    4. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    5. Han, Li-Ming & Lai, Gene C. & Witt, Robert C., 1997. "A financial-economic evaluation of insurance guaranty fund system: An agency cost perspective," Journal of Banking & Finance, Elsevier, vol. 21(8), pages 1107-1129, August.
    6. Duan, Jin-Chuan & Yu, Min-Teh, 2005. "Fair insurance guaranty premia in the presence of risk-based capital regulations, stochastic interest rate and catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2435-2454, October.
    7. Hato Schmeiser & Joël Wagner, 2013. "The Impact of Introducing Insurance Guaranty Schemes on Pricing and Capital Structure," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 80(2), pages 273-308, 06.
    8. Jeffrey R. Brown, 2007. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," NBER Working Papers 13438, National Bureau of Economic Research, Inc.
    9. Kalra, Raman & Jain, Gautam, 1997. "A continuous-time model to determine the intervention policy for PBGC," Journal of Banking & Finance, Elsevier, vol. 21(8), pages 1159-1177, August.
    10. Sandra Blome & Kai Fachinger & Dorothee Franzen & Gerhard Scheuenstuhl & Juan Yermo, 2007. "Pension Fund Regulation and Risk Management: Results from an ALM Optimisation Exercise," OECD Working Papers on Insurance and Private Pensions 8, OECD Publishing.
    11. Pennacchi, George G & Lewis, Christopher M, 1994. "The Value of Pension Benefit Guaranty Corporation Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(3), pages 735-53, August.
    12. Fiona Stewart, 2007. "Benefit Security Pension Fund Guarantee Schemes," OECD Working Papers on Insurance and Private Pensions 5, OECD Publishing.
    13. David A. Love & Paul A. Smith & David Wilcox, 2009. "Should risky firms offer risk-free DB pensions?," Finance and Economics Discussion Series 2009-20, Board of Governors of the Federal Reserve System (U.S.).
    14. Cummins, J David, 1988. " Risk-Based Premiums for Insurance Guaranty Funds," Journal of Finance, American Finance Association, vol. 43(4), pages 823-39, September.
    15. Przemysław Rymaszewski & Hato Schmeiser & Joël Wagner, 2012. "Under What Conditions Is an Insurance Guaranty Fund Beneficial for Policyholders?," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(3), pages 785-815, 09.
    16. Chen, An, 2011. "A risk-based model for the valuation of pension insurance," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 401-409.
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