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The Pension Protection Fund

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  • David McCarthy
  • Anthony Neuberger
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    Abstract

    We develop a model of the Pension Protection Fund (PPF), a defined benefit pension guarantee system for the UK, based on an analogy between pension liabilities and corporate debt obligations. We show 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. The cause of this problem is the double impact of a fall in equity prices on the PPF: it makes sponsor firms more likely to default and it makes defaulted plans more likely to be underfunded. We use our model to derive a fair premium for PPF insurance under different circumstances, to estimate the extent of cross-subsidies in the PPF between strong and weak sponsors, and to show that risk-rated premiums are unlikely to have a substantial effect on either the size or the lumpiness of claims. We argue that for the PPF to operate effectively, it should be introduced in tandem with strong minimum funding requirements and a lower level of benefit guarantee than at present.

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    Bibliographic Info

    Article provided by Institute for Fiscal Studies in its journal Fiscal Studies.

    Volume (Year): 26 (2005)
    Issue (Month): 2 (June)
    Pages: 139-167

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    Handle: RePEc:ifs:fistud:v:26:y:2005:i:2:p:139-167

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    Cited by:
    1. David Blake & John Cotter & Kevin Dowd, 2011. "Financial Risks and the Pension Protection Fund: Can it Survive Them?," Papers 1103.5978, arXiv.org.

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