Moral Hazard and Pension Insurance in the U.S

By Arvin, B. Mak; Drewes, Torben | Atlantic Economic Journal, September 1992 | Go to article overview

Moral Hazard and Pension Insurance in the U.S


Arvin, B. Mak, Drewes, Torben, Atlantic Economic Journal


Recent bank and thrift failures have meant record deposit insurance payments from the Federal Deposit Insurance Corporation and the Federal Savings and Loan Insurance Corporation, placing a large burden on American taxpayers. These federal agencies introduce a problem of moral hazard as banks and thrifts can borrow at risk-free rates by issuing insured deposits and then invest in high yield, risky assets [Keeley, AER, 1990].

This paper discusses a lesser known problem of moral hazard-the insurance of private sector defined benefit pension plans by the Pension Benefit Guaranty Corporation (PBGC). This federal agency was established in 1974 to insure employee benefits against termination of defined benefit plans by firms, whether that termination is voluntary (subject to certain legal and procedural restrictions) or involuntary (e.g., due to bankruptcy). It is contended that the premium structure can be improved to deal with the moral hazard problem more effectively.

From 1974-87, the firms paid an annual, flat-rate premium that rose steadily from $1 per employee to $8.50. In 1988, PBGC introduced a premium of $16 per employee plus 0.6 percent of the actuarial deficiency of the plan. The total premium was capped at $50 per employee. In 1991, the premium was increased to $19 per employee plus 0.9 percent of the actuarial deficiency and capped at $72 per employee. Despite the new variable premium, however, PBGC admits that the insurance is grossly underpriced for those plans that are underfunded. These plans' payments currently account for only 18 percent of total premium revenues. …

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