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Reforming the Defined-Benefit Pension System

Author

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  • David W. Wilcox

    (Board of Governors of the Federal Reserve System)

Abstract

Defined-benefit pensions typically expose workers to a form of financial risk that they are ill positioned to bear and unable to hedge. If workers understand that risk, they will offer employers a lower “price” (in the form of salary concessions) than the capital markets would offer for the same cash flow. The resulting financial inefficiency reduces the value of the firm sponsoring the pension plan. The paper identifies reforms that would essentially eliminate the financial risk borne by workers and hence the financial inefficiency inherent in risky pensions. It would also essentially eliminate the substantial financial exposure currently borne by taxpayers. The key reform elements are tighter rules governing funding and portfolio investment, market-oriented pricing of the insurance offered by the Pension Benefit Guaranty Corporation, and improved disclosure of information related to pension plans in firms’ public financial statements, in the federal budget, and in statements provided to workers.

Suggested Citation

  • David W. Wilcox, 2006. "Reforming the Defined-Benefit Pension System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 37(1), pages 235-304.
    • Handle: RePEc:bin:bpeajo:v:37:y:2006:i:2006-1:p:235-304
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    File URL: https://www.brookings.edu/wp-content/uploads/2006/03/2006a_bpea_wilcox.pdf
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    References listed on IDEAS

    as
    1. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    2. Julia Lynn Coronado & Steven A. Sharpe, 2003. "Did Pension Plan Accounting Contribute to a Stock Market Bubble?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 323-371.
    3. Pennacchi, George, 2006. "Deposit insurance, bank regulation, and financial system risks," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 1-30, January.
    4. Pesando, James E, 1982. "Investment Risk, Bankruptcy Risk, and Pension Reform in Canada," Journal of Finance, American Finance Association, vol. 37(3), pages 741-749, June.
    5. Jeremy Gold & Nick Hudson, 2003. "Creating Value In Pension Plans (Or, Gentlemen Prefer Bonds)," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(4), pages 51-57, September.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Jeffrey R. Brown, 2008. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," Journal of Economic Perspectives, American Economic Association, vol. 22(1), pages 177-198, Winter.
    2. Thomas Crossley & Mario Jametti, 2013. "Pension Benefit Insurance and Pension Plan Portfolio Choice," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 337-341, March.
    3. Mario Jametti, 2007. "Underfunding of Defined Benefit Pension Plans and Benefit Guarantee Insurance - An Overview of Theory and Empirics," Working Papers 2007_1, York University, Department of Economics.
    4. David G. Lenze, 2009. "Accrual Measures of Pension-Related Compensation and Wealth of State and Local Government Workers," BEA Working Papers 0054, Bureau of Economic Analysis.
    5. Qian, Linyi & Shen, Yang & Wang, Wei & Yang, Zhixin, 2019. "Valuation of risk-based premium of DB pension plan with terminations," Insurance: Mathematics and Economics, Elsevier, vol. 86(C), pages 51-63.
    6. Romaniuk, Katarzyna, 2021. "Pension insurance schemes and moral hazard: The Pension Benefit Guaranty Corporation should restrict the insured pension plans’ portfolio policy," The Quarterly Review of Economics and Finance, Elsevier, vol. 82(C), pages 37-43.
    7. Love, David & Smith, Paul A. & Wilcox, David, 2007. "Why Do Firms Offer Risky Defined–Benefit Pension Plans?," National Tax Journal, National Tax Association;National Tax Journal, vol. 60(3), pages 507-519, September.
    8. Mario Jametti, 2008. "Underfunding of Defined Benefit Pension Plans and Benefit Guarantee Insurance: An Overview of Theory and Evidence," Canadian Public Policy, University of Toronto Press, vol. 34(s1), pages 39-46, November.
    9. Jeffrey R. Brown & David W. Wilcox, 2009. "Discounting State and Local Pension Liabilities," American Economic Review, American Economic Association, vol. 99(2), pages 538-542, May.
    10. Chen, An, 2011. "A risk-based model for the valuation of pension insurance," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 401-409.
    11. Chen, An & Uzelac, Filip, 2014. "A risk-based premium: What does it mean for DB plan sponsors?," Insurance: Mathematics and Economics, Elsevier, vol. 54(C), pages 1-11.
    12. Séverine Arnold & Anca Jijiie, 2020. "Retirement Ages by Socio-Economic Class," Risks, MDPI, vol. 8(4), pages 1-40, October.
    13. Anca-Stefania Jijiie & Jennifer Alonso Garcia & Séverine Arnold (-Gaille), 2019. "Mortality by socio-economic class and its impact on the retirement schemes: How to render the systems fairer?," ULB Institutional Repository 2013/300032, ULB -- Universite Libre de Bruxelles.

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    More about this item

    Keywords

    macroeconomics; defined-benefit pension; pension system; financial risk;
    All these keywords.

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • J32 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Nonwage Labor Costs and Benefits; Retirement Plans; Private Pensions
    • J38 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Public Policy

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