Variable rate premiums and defined benefit pension funding

Abstract

This study investigates the association between variable rate premiums (VRPs) charged by the Pension Benefit Guaranty Corporation (PBGC) and defined benefit pension funding in the United States. The PBGC requires VRPs from firms that fail to adequately fund their pension plans. Because millions rely on pension income, it is important to understand how government incentives impact pension funding decisions. In the aggregate, VRPs are positively associated with increases in pension funding. However, these premiums are not associated with excess pension contributions (EPCs) for financially distressed firms. These results suggest that financially distressed US firms engage in risk shifting. The lack of association persists even for financially distressed firms with tax benefits associated with pension funding. Finally, the association between VRPs and EPCs holds only for firms with combined lower borrowing costs and higher premiums. This finding suggests that higher premiums are not an effective incentive when firms also face higher borrowing costs and that lower premiums are not an effective incentive for EPCs, regardless of a firm's borrowing cost.