April 24, 2008
CBO issued a letter today reviewing a new investment policy recently adopted by the Pension Benefit Guaranty Corporation (PBGC). As part of its analysis, CBO reviewed the assumptions underlying PBGCs decision and assessed the revised policy's potential for affecting the corporation's ability to meet its obligation to retirees and for increasing costs to taxpayers.
- Prior to February of this year, PBGCs investment strategy was to hold about 75 percent of its portfolio in bonds, with the duration of those assets matched to the corporations obligations. The remainder of the portfolio was invested in equities. PBGCs new strategy reduces to 45 percent its allocation to fixed-income assets, in order to increase the proportion devoted to equities (45 percent) and to further diversify into alternative asset classes (10 percent).
- The change in investment strategy represents an effort on the part of PBGC to increase the expected returns on its assets and to diminish the likelihood that taxpayers will be called on to cover some of its liabilities. The new strategy is likely to produce higher returns, on average, over the long run. But the new strategy also increases the risk that PBGC will not have sufficient assets to cover retirees' benefit payments when the economy and financial markets are weak. By investing a greater share of its assets in risky securities, PBGC is more likely to experience a decline in the value of its portfolio during an economic downturn -- the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans. If interest rates fall at the same time that the overall economy and financial markets decline, the present value of benefit obligations will increase, and the pension plans likely to be assumed by PBGC will be even more underfunded as a result.
- The effect on taxpayers of the change in PBGCs investment strategy depends on assumptions about future premiums and benefits and expectations about the governments ultimate responsibility to covered retirees. Although the Employee Retirement Income Security Act of 1974 (ERISA) explicitly states that the federal government does not stand behind PBGC's obligations, an implicit expectation exists among many market participants and policymakers that taxpayers will ultimately pay for benefits should PBGC be unable to meet those obligations. If policies governing future premiums and benefits remain unaffected by the new investment policy, taxpayer's increased risk of substantial losses will be balanced by the higher expected returns that the new policy allows. However, if the higher expected returns mean that premiums are reduced or benefits increased relative to what would otherwise occur, plan sponsors or beneficiaries will reap some of the benefits of the change in investment policy, but taxpayers will bear the added risks.