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Pension benefit default risk and welfare effects of funding regulation

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    Abstract

    This paper analyzes the welfare effects of funding regulation for defined benefit pension plans subject to pension benefit default risk in an incomplete financial markets OLG-setting with aggregate uncertainty and idiosyncratic pension default risk. The financial market incompleteness arises from the inability to trade human capital claims. Using numerical methods to solve for equilibrium, we show first that default-free defined benefit pension plans are welfare-improving even in a dynamically efficient economy. Second, we show that in the presence of default risk funding regulations improve aggregate welfare by making larger size plans more attractive and that full funding is not necessarily the optimal policy. Our results provide a rationale for the widespread underfunding of defined benefit pension plans and might explain the decline of these plans after the introduction of stringent funding regulation in the US

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    Bibliographic Info

    Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 147.

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    Date of creation: 01 Nov 2005
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    Handle: RePEc:sef:csefwp:147

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    Keywords: generations; pension default; funding regulation;

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