PBGC and Risk-Based Premiums
In his just proposed federal budget, President Barack Obama opens the door for the Pension Benefit Guaranty Corporation ("PBGC") to determine insurance premiums as a function of the riskiness of the plan sponsor. Having been an advocate for this approach for numerous years, my response is "yippee yahoo." There is empirical evidence aplenty about the costly consequences of forcing good risks to subsidize bad risks. The common sense notion of charging plan sponsors higher insurance premiums if they are deemed "higher risk" is logical and is a long overdue move in the right direction.
The excerpted text from "Low Risk Premium Makes PBGC Bargain Insurer" (In the Money, Dow Jones Newswires, July 18, 2005) by Steven D. Jones addresses the concept of risk-based premiums as follows:
A separate bill that emerged from a House committee in June changes a number of rules governing funding levels and grace periods to meet them. It also ties premiums for PBGC coverage to hikes in the national wage index. But the formula wouldn't impose higher premiums on higher risk plans. "That's a mistake, says consultant Susan Mangiero, author of Risk Management for Pensions, Endowments and Foundations." To be effective, a premium structure needs to reflect the risk of the insured. Without a risk mechanism, "you invite adverse selection" in the insurance plan, she says. For example, a driver with several tickets and an accident record pays more for auto insurance. If there's no cost to the behavior, the carefree driver has no incentive to change, losses mount and premiums go up for every participant. Discouraged by the cost, clients with good risk profiles leave the plan. Companies can't seek pension insurance elsewhere, but they can end defined-benefit plans and shift to defined-contribution plans, such as a 401(k), in which employees share the risk. Such plans are not covered by the PBGC. "The net effect of flat-based insurance, not taking into account different risk levels, is that you have a riskier system, which is counter to the purpose of having an insurance plan," she says.
Think about the issue this way. Would you buy stocks or bonds issued by a public insurance company that charged the same premium for all insured parties, irregardless of their risk behavior? Hopefully your answer is "of course not."
If plan sponsors do the right thing in terms of careful risk-taking and good procedural prudence, they should not be penalized by having to pay for the sins of others who are less careful or, worse yet, sloppy, indifferent and/or take excessive risks unnecessarily and to the detriment of their plan participants.
Note to Readers: Check out "Obama's 2012 Budget: What It Means for Pension Plans and the PBGC" by John Sullivan, Advisor One, February 16, 2011, "Let PBGC set employer premiums based on risk: Obama" by Jerry Geisel, Business Insurance, February 14, 2011 and "Budget Would Raise Pension-Insurance Costs" by David Wessell (Wall Street Journal, February 14, 2011).
