CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

SEPTEMBER 2005

The Risk

Exposure of

the Pension

Benefi t Guaranty

Corporation

CBO
CBO
The Congress of the United States O Congressional Budget Office

CBO

The Risk Exposure of the

Pension Benefit Guaranty Corporation

September 2005

A

PAPER
Note

The cover photograph comes from the Bethlehem Steel Company.
Preface

The recent transfer of several large defined-benefit pension plans to the federal Pension 

Benefit Guaranty Corporation (PBGC) by U.S. airline and steel companies has drawn attention to the potential cost of the government’s pension insurance program. Although current 

law gives PBGC no claim on federal financial resources, the possibility of lost pension benefits 

or future federal legislation to cover those losses has increased interest in policies to strengthen 

PBGC’s finances. 

Evaluating such policies is complicated by the budgetary treatment of PBGC. Under current 

practice, some of the effects of policy changes are not recognized in the budget for many years. 

House Budget Committee Chairman Jim Nussle has asked the Congressional Budget Office 

(CBO) to evaluate the current budgetary treatment of PBGC and identify changes in 

accounting that would increase the accuracy, relevance, and reliability of budget estimates for 

insurance and related federal programs. 

This paper is a partial response to the Chairman’s request. It estimates the market value of federal pension insurance, analyzes options for reducing future shortfalls, and identifies budgetary alternatives that would make PBGC’s finances more transparent to the Congress and the 

public. Consistent with CBO’s mandate to provide objective, impartial analysis, the report 

makes no recommendations.

Wendy Kiska (CBO), Deborah Lucas (Northwestern University and the National Bureau of 

Economic Research), and Marvin Phaup (CBO) prepared the report under the direction of 

Roger Hitchner and Robert Dennis. (Roger Hitchner has since left CBO.) The authors thank 

Robert McDonald (Northwestern University) for valuable discussions. Paul Cullinan, Thomas DeLeire, Geoff Gerhardt, and Bruce Vavrichek offered helpful suggestions. Steven Weinberg provided programming assistance, and Amina Masood (formerly of CBO) assisted with 

research. Comments were also provided by seminar participants at CBO; the Northwestern 

University Law and Economics Colloquium; and the Finance Department, Kellogg School of 

Management, Northwestern University. 

Janey Cohen edited the paper, with assistance from Christian Spoor, and Christine Bogusz 

proofread it. Rae Roy formatted the initial text and tables. Maureen Costantino prepared the 

paper for publication and designed the cover. Lenny Skutnik produced printed copies of the 

paper, and Annette Kalicki and Simone Thomas produced the electronic version for CBO’s 

Web site (www.cbo.gov). 

Douglas Holtz-Eakin

Director

September 2005

Summary vii

Introduction: The Pension Benefit Guaranty Corporation and the 

Employee Retirement Income Security Act 1

Estimates of PBGC’s Shortfall 3

A Prospective Market-Value Measure 5

CBO’s Estimates 6

Options to Reduce Federal Costs 8

Changing Premiums 8

Regulating Pension-Investment Risk 10

Changing the Rules for Calculating Pension Liabilities 11

Options to Increase Transparency 13

Alternative Budgetary Treatments 13

Privatization 14

Appendix A: The Pension Benefit Guaranty Corporation’s 

Financial Data: Single-Employer and Multiemployer Programs 15

Appendix B: Accounting and Funding Measures of Firms’ 

Pension Liabilities and Underfunding 17

Appendix C: The Congressional Budget Office’s Pricing Model 

for the Pension Benefit Guaranty Corporation 19

Appendix D: Reconciling CBO’s Estimates of Underfunding with

Those of the Pension Benefit Guaranty Corporation 27

Appendix E: Sensitivity Analysis 29

CONTENTS
CONTENTS vi

Tables

S-1. PBGC’s Past and Projected Costs for Single-Employer Plans viii

S-2. Estimated Effects of Selected Policy Changes on PBGC’s 

Net Costs for Single-Employer Plans Over Ten Years ix

1. PBGC’s Ten Largest Claims, 1975 to 2004 3

2. Obligations and Collections of PBGC’s On-Budget 

Account, 2004 4

3. Financial Statements for PBGC’s Single-Employer 

Program as of September 30, 2004 5

4. PBGC’s Projected Annual Claims 6

5. PBGC’s Prospective Net Costs for Single-Employer 

Plans Over 10-, 15-, and 20-Year Horizons 7

6. Estimated Effects of Selected Policy Changes on PBGC’s 

Net Costs for Single-Employer Plans Over Ten Years 9

7. Reported Funding Levels and Premium Payments for the 

Bethlehem Steel and US Airways Pilots’ Plans, 

1996 to 2002 12

8. Net Cost to PBGC of a Permanently Higher Discount Rate 13

A-1. PBGC’s Assets, Liabilities, and Net Financial Position for 

Single-Employer and Multiemployer Plans, 1980 to 2004 16

C-1. Sources and Uses of Data for CBO’s Model 20

C-2. Assumptions of CBO’s Model 21

D-1. CBO’s Measures of Pension Liabilities, 2003 28

E-1. Premium Multiples to Equalize Costs Across Risk Groups 30
Summary

The Pension Benefit Guaranty Corporation (PBGC), 

an agency of the federal government, has recently taken 

over several large pension plans of bankrupt U.S. airline 

and steel companies. At the same time, the agency’s own 

financial condition has worsened, raising the specter of a 

sharply reduced pension for some insured workers or the 

need to provide taxpayers’ dollars to PBGC. Under current law, PBGC insures pension benefits only to the extent that it has assets to make such payments from premiums, investment income, assets of failed pension plans, 

and recoveries from bankrupt plan sponsors. Although 

PBGC has no legal claim on the general fund of the Treasury, many policymakers and observers believe that a major shortfall at PBGC would prove untenable because the 

government has provided an implicit guarantee of pension plans—and that the law would be changed to provide the resources necessary to avoid losses of federally insured pension benefits by retirees. That prospect has 

prompted a search for policy changes that would reduce 

or eliminate projected losses. To inform such policies, this 

paper describes the key features of the current system, 

measures the current shortfall, and evaluates the effects of 

various policy alternatives on prospective losses.

Defined-benefit pensions are a form of employee compensation that is earned during working years but paid 

during retirement. To ensure payment of that deferred 

compensation, firms are required to put aside funds to 

meet the liabilities and to purchase insurance through the 

payment of premiums to PBGC. PBGC takes over (“terminates”) defined-benefit pension plans sponsored by a 

single employer when that sponsor becomes insolvent 

and is unable to meet its pension obligations. In doing so, 

PBGC seizes the assets of the pension plan and assumes 

responsibility for paying insured pension benefits. Its loss 

on those plan terminations is the excess of insured plan liabilities over plan assets. 

CBO’s Estimates

The Congressional Budget Office (CBO) estimates that 

the present value of PBGC’s net costs for defined-benefit 

pension insurance for single-employer plans over the next 

10 years is about $86.7 billion. That total consists of two 

distinct components: $23.3 billion of losses from insurance claims for plans that have already terminated or 

whose termination is imminent, and $63.4 billion of prospective losses over the next 10 years for terminations that 

have not yet occurred, net of future premiums1 (see Summary Table 1). Total costs (“sunk”—for plans that have 

been terminated—and prospective) for 15- and 20-year 

horizons are $119 billion and $141.9 billion, respectively.

Those estimates are the market value of insurance—the 

price that a private insurer would charge to accept the insurance obligations of PBGC for all plans that terminate 

over the time period. The value reflects the discounted 

cost of covered benefit payments over the lifetime of beneficiaries. It also incorporates a charge for the cost of market risk, a cost that arises because investors demand compensation for the fact that new claims are likely to be 

higher in bad economic times, when more sponsoring 

firms fail, and the value of pension assets are depressed. 

Those market-value estimates should not be confused 

with budget estimates, which differ in two critical respects. First, under current law, PBGC is authorized to 

pay insured benefits only to the extent that it has acquired resources to do so from premiums, assets of terminated plans, investment income, and recoveries from 

bankrupt plan sponsors. Thus, federal liability and the 

1. That estimate is extrapolated from directly estimated costs of 

$55.6 billion for a subset of insured plans with a total of about 

$1.4 trillion in plan liabilities for which recent data are available. 

Total liabilities of all defined-benefit plans are estimated by PBGC 

to be about $1.6 trillion as of January 1, 2003, implying a sampleto-universe scaling factor of 1.14. Unless otherwise noted, all estimates of future losses include that scaling factor.
viii THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Summary Table 1.

PBGC’s Past and Projected Costs for 

Single-Employer Plans

(Billions of dollars)

Source: Congressional Budget Office based on information from 

the Pension Benefit Guaranty Corporation.

a. Estimated price that a private insurer would charge, in addition 

to current premiums, to accept the obligations arising from terminations over the indicated time period.

maximum budget cost of pension insurance are limited. 

In contrast, CBO’s estimate of market value is for the entire shortfall, without regard to the current-law limitation 

on federal financial responsibility. Second, even if the 

Congress enacted legislation to guarantee PBGC’s obligations, insurance programs are budgeted for on a cash basis, whereas CBO’s present-value estimates take into account benefits that are paid far beyond the 10-year 

budget window. 

CBO’s estimate of $86.7 billion indicates that PBGC’s 

accumulated deficit of $23.3 billion significantly understates the financial exposure from PBGC insurance. That 

is because PBGC’s accumulated deficit does not include 

losses expected to be incurred in the future under current 

policy, beyond those that are imminent. Thus, even if the 

Congress provided funding to cover the currently reported shortfall, a large structural imbalance would remain between the value of PBGC’s premiums and other 

income, and the prospective cost of future plan terminations. But current estimates of underfunding by pension 

plans—amounting to more than $450 billion—significantly overstate PBGC’s financial risk. Most sponsors of 

underfunded defined-benefit plans probably will make 

up the current shortfalls through future contributions to 

the plans, although the condition of a smaller number of 

sponsors and plans will deteriorate over time.

Policy Options to Reduce Federal Costs

Several policy options are available to the Congress to induce plan sponsors to more fully absorb the costs of their 

pension commitments and thus to reduce prospective 

losses. Effective options fall into two broad categories: increasing premiums to better reflect the value of insurance; 

and increasing sponsor resources by tightening the rules 

that govern investment, accounting, and funding. Although such changes would tend to reduce the financial 

shortfall of the defined-benefit pension system, they also 

would affect the incentives of plan sponsors, both with 

respect to taking risks and continuing to offer definedbenefit pensions. Raising the costs to sponsors would 

tend to push some employers toward lower-cost options, 

such as defined-contribution plans, which shift investment risk to employees, or toward other forms of compensation. 

Increasing PBGC’s revenues by raising premiums could 

be structured in a variety of ways. One would preserve 

the prevailing structure: a fixed charge per participant 

plus a variable charge based on how much the plan is underfunded. In that case, CBO estimates that raising rates 

so that, in market-value terms, the present value of expected future losses would equal the present value of premium income, would require both the fixed and variable 

portions of the annual premium to be increased by a factor of 6.5. 

Alternatives to simply scaling up the components of the 

current premium include tying premiums more closely to 

plan or sponsor risk. For instance, linking premiums to 

pension-asset risk could discourage excessive risk in plan 

investments. Other options that would also more closely 

align premiums with plan risk, and reduce cross-subsidies 

among sponsors, include basing premiums on the dollar 

value of insurance coverage rather than assessing a per 

capita fee, and charging higher premiums to plan sponsors with lower credit ratings.

A large rate increase could cause sponsors to drop existing 

plans and discourage new entrants into the definedbenefit system. The effect of reduced participation on insurance value, however, is ambiguous. On the one hand, 

to the extent that higher premiums discourage participaMarket Valuea

Accumulated Deficit, as of

September 30, 2004 23.3

Prospective Net Costs

Over 10 years 63.4

Over 15 years 95.7

Over 20 years 118.6

Total

Over 10 years 86.7

Over 15 years 119.0

Over 20 years 141.9
SUMMARY ix

Summary Table 2.

Estimated Effects of Selected Policy 

Changes on PBGC’s Net Costs for

Single-Employer Plans Over Ten Years

(Billions of dollars)

Source: Congressional Budget Office.

a. Estimated price that a private insurer would charge, in addition 

to current premiums, to accept the obligations arising from 

terminations over 10 years.

tion by financially healthier sponsors, the estimates of the 

gains from higher premiums are overstated. On the other 

hand, policies that reduce participation have the effect of 

limiting the scope of coverage, thereby further reducing 

exposure. This paper does not attempt to quantify possible changes in participation as a result of policy changes. 

Higher premiums, even if partially risk-based, would not 

significantly reduce the inherent risk of large losses arising 

in the future from underfunded sponsors. Policy options 

that would control costs by reducing future shortfalls include the following: matching more closely the expected 

cash inflows from pension assets with the expected cash 

outflows from pension liabilities by limiting the share of 

pension assets invested in stocks and other high-risk securities; incorporating the higher expected value of a plan’s 

liabilities in the event of termination into the actuarial 

calculation of current liabilities; requiring the use of current (rather than lagged) market rates to calculate liabilities; and requiring more rapid closure of funding gaps 

when they arise. For instance, if the share of pension assets invested in equities was limited to 30 percent rather 

than the current unregulated level of about 70 percent, 

prospective insurance costs over 10 years would decrease 

by an estimated $9.9 billion (see Summary Table 2). In 

general, tighter funding rules have the potential to significantly reduce the government’s risk but at the expense of 

imposing higher funding costs on plan sponsors. Higher 

funding costs, similar in effect to a premium hike, could 

discourage participation in the defined-benefit system. 

The advantage to such structural changes over premium 

increases, however, is that they tend to reduce system risk 

as well as lower expected costs.

Some policy changes under consideration would raise 

PBGC’s net costs. For example, making permanent the 

increase in the discount rate specified in the Pension Equity Funding Act would reduce sponsors’ contributions 

and increase 10-year prospective costs by over $8 billion.

Policy Options to Increase 

Transparency

Greater transparency in the defined-benefit pension system might contribute to reduced future losses and could 

take two forms. One would be to increase the transparency of pension assets and liabilities. That would permit 

shareholders, employees, and PBGC to better monitor 

the financial condition of plans. A second approach 

would be to increase the transparency of PBGC’s financial status and thus permit the Congress to better monitor the agency’s operations. An important consideration 

in the latter approach is the extent to which the Congress 

chooses to recognize the costs of pension insurance in the 

budget when they are incurred rather than when the cash 

outflows occur many years later; that is, to adopt some 

form of accrual budgetary accounting for PBGC. 

Market Valuea

PBGC’s Prospective Net Costs Over 10 

Years Under Current Law 63.4

Effect of Policy Change

Increase annual premium 6.5 times -63.4

Limit a pension plan’s investments in 

equities to 30 percent of plan assets -9.9

Make permanent the increase in 

discount rates for calculating pension 

liabilities 8.1

The Risk Exposure of the 

Pension Benefit Guaranty Corporation

Introduction: The Pension Benefit 

Guaranty Corporation and the 

Employee Retirement Income

Security Act

The Pension Benefit Guaranty Corporation (PBGC), an 

agency of the U.S. government, insures pension benefits 

for workers and retirees covered by most defined-benefit 

plans provided by private companies.1

 Defined-benefit 

plans generally provide a prescribed level of benefits to 

eligible retirees based on their tenure with the sponsoring 

employer and their wages.2 About 44 million participants 

in more than 31,000 defined-benefit plans are currently 

protected by PBGC. From its inception in 1974 through 

fiscal year-end 2004, PBGC has assumed responsibility 

for the guaranteed benefits of participants in about 3,500 

underfunded plans with financially troubled sponsors. 

Consequently, the agency is obligated to pay more than 

$3 billion annually to 500,000 retirees whose plans have 

now been taken over by PBGC. Another 550,000 participants who are not yet retired are owed benefits under terminated plans administered by PBGC. 

PBGC insures two types of defined-benefit plans: multiemployer and single-employer plans. Multiemployer 

plans typically are collectively bargained and offered 

jointly by two or more unrelated employers, usually in 

the same industry, such as construction or transportation. 

Single-employer plans are the responsibility of a single 

sponsoring firm. Multiemployer programs expose PBGC 

to much less risk than single-employer plans, because 

multiemployer sponsors are jointly responsible for funding benefits and the level of guaranteed benefits is relatively low. PBGC’s liability for multiemployer plans is 

currently $1.3 billion.3

 Because of differences in the types 

of plans and the risks to and responsibilities of PBGC, 

the law requires PBGC to report on the performance of 

single- and multiemployer programs separately. Unless 

otherwise noted, the data and estimates in this paper are 

for single-employer plans only.4 

PBGC was created in 1974 under the Employee Retirement Income Security Act (ERISA). Enactment of 

ERISA was prompted in part by the failure of the Studebaker Company, whose underfunded plan left many 

workers with sharply reduced pension benefits. PBGC 

provides insurance to employees by assuming responsibility—subject to specified limits—for unfunded pension liabilities or the difference between a plan’s insured liabilities and its assets when the sponsoring company is unable 

to meet its pension obligations. 

1. For more details on the defined-benefit pension system and the 

operations of PBGC, see Congressional Budget Office, A Guide to 

Understanding the Pension Benefit Guaranty Corporation (September 2005).

2. Such plans are distinguished from defined-contribution plans, 

which provide only the level of benefits that may be financed 

through the investment of specified contributions from the 

employer and employee to the plan. 

3. PBGC provides loans to troubled multiemployer plans rather than 

taking over the plans, but many of the loans end in default. The 

reported liability for multiemployer plans is the present value of 

projected future assistance for plans receiving support from PBGC 

on September 30, 2004. 

4. Financial data for the multiemployer and single-employer programs are reported in Appendix A.
2 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Although ERISA increased retirement security, some benefits remain at risk from the bankruptcy of a plan sponsor. Earned benefits are not guaranteed if they exceed 

PBGC’s cap on annual benefits5 or if they are subject to 

exclusion because they were granted within five years of a 

plan’s termination. Further, vested benefits—which in an 

ongoing plan rise with a worker’s wages and tenure—are 

fixed when the plan terminates, thus eliminating a valuable feature of ongoing pension plans. PBGC-insured 

benefits also are subject to reduction if the employee retires before age 65, which affects many retirement-eligible 

employees of financially distressed firms. 

ERISA also regulates plan sponsors in ways that are intended to limit PBGC’s losses. Those measures include 

mandatory premiums levied on plan sponsors, funding 

rules that limit pension underfunding, mandatory disclosure of pension funding levels to participants, and requirements for additional sponsor contributions to close 

gaps between plan assets and liabilities. ERISA permits 

sponsors some latitude in the valuation of pension assets 

and liabilities and in permitting sponsors to amortize 

funding shortfalls over several years. Sponsors must comply with Internal Revenue Code (IRC) requirements to 

qualify for the preferential tax treatment of income available to participants in qualified plans.6 However, the IRC 

also limits the amount of pension overfunding that is taxpreferred to prevent abuse of the tax preference. 

Fully funded plans can become underfunded as a result of 

fluctuations in interest rates and stock market prices and 

from changes in the actuarial assumptions used to calculate required contributions. Accordingly, PBGC is subject 

to considerable financial risk. That risk is evident in the 

wide fluctuations in funding of insured plans over time. 

For example, plan underfunding reported to PBGC varied from $29 billion (1997) to $7 billion (2000) to $354 

billion (2004).7 Some of that risk also is reflected in the 

swings in PBGC’s reported deficit, which more than doubled between 2003 and 2004. The recent spate of large 

losses is attributable to the termination of a few large underfunded plans (see Table 1). The bankruptcies of Bethlehem Steel and LTV in 2003 left the PBGC to cover 

$3.7 billion and nearly $2 billion, respectively, in underfunded insured liabilities. More recently, PBGC assumed 

all of the pension plans of US Airways, at a cost of $3 billion, and agreed to take over certain plans of United Airlines, which has a gap between funded and guaranteed 

benefits of more than $6 billion.8

The risk of additional losses remains high, with 59 percent to 84 percent of large covered plans reporting funding gaps in excess of 10 percent in 2003.9 The current, 

historically high level of underfunding can be attributed 

to the decline of the equity market from its peak in 

March 2000, which eroded the value of pension assets, 

and the simultaneous drop in interest rates, which caused 

the present value of pension liabilities to increase 

sharply.10 The historically high figure reported by PBGC 

for “reasonably possible” losses (defined as underfunding 

5. The statutory ceiling on guaranteed benefits for single-employer 

plans, which is indexed to the change in the Social Security wage 

base, is $3,801 per month, or $45,612 per year, for a single life 

annuity payable at age 65 for plans terminating in 2005. Benefits 

may exceed the ceiling if the plan has sufficient assets to fund 

them. See House Committee on Ways and Means, Green Book 

(2004), Section 14, pp. 1-16. For multiemployer plans, the ceiling 

is lower: $12,870 per year for a participant with 30 years of service 

under the plan. That ceiling is adjusted periodically by legislation 

rather than by linking it directly to the value of a related economic 

variable.

6. Similar tax treatment applies to qualifying defined-contribution 

plans, which also are subject to ERISA.

7. That amount of underfunding differs from the more widely 

reported estimate of more than $450 billion for the universe of 

plans. The smaller number is based on reports required of plans 

that are underfunded by more than $50 million or have large outstanding liens for missed contributions or Internal Revenue Service funding waivers. For details, see Pension Benefit Guaranty 

Corporation, Pension Insurance Data Book 2003 (Spring 2004), 

Table S-45, available at www.pbgc.gov/publications/databook. For 

2003-2004 values, see the Statement of Bradley D. Belt, Executive 

Director, Pension Benefit Guaranty Corporation, before the Senate Committee on the Budget, June 15, 2005.

8. Despite their substantial effect on PBGC’s financial position, steel 

companies and airlines together constitute only 5 percent of the 

participants covered by PBGC.

9. That statistic is based on the percentage of public firms covered by 

Compustat, the company information service of Standard & 

Poor’s, that have a defined-benefit pension plan. The percentage 

of plans that are underfunded depends on the definition of liabilities (see Appendix B).

10. The Standard & Poor’s 500 Index declined by nearly 50 percent 

between March 2000 and October 2002. Over that period, the 

interest rate on 10-year Treasury notes fell from 6.26 percent to 

3.94 percent. 
THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION 3

Table 1.

PBGC’s Ten Largest Claims, 1975 to 2004

Source: Congressional Budget Office based on Pension Benefit Guaranty Corporation, Pension Insurance Data Book (2004).

Notes: Other large pension plans, including those of US Airways and United Airlines, have been terminated since 2004 or are pending

termination.

n.a. = not applicable.

a. Multiple years indicate that the firm has multiple plans with different termination dates.

in plans sponsored by below-investment-grade sponsors) 

of $96 billion in 2004 further reflects the deterioration in 

the credit quality of a number of large U.S. corporations 

over the same period. 

Current law sets higher premiums for substantially underfunded plans and, with exceptions based largely on 

prior contributions, firms are required to increase their 

plan contributions to amortize shortfalls between plan assets and liabilities. The annual insurance premium is $19 

per participant, but significantly underfunded sponsors 

must pay an additional annual premium of $9 per $1,000 

of unfunded vested benefits. Sponsors with plans that are 

less than 90 percent funded based on a “current liability” 

basis also are required to make deficit reduction contributions that close the funding gap over a period of approximately three to five years.11 Nonetheless, Internal Revenue Service funding limitations and credit balances from 

prior years, among other provisions of law, enable some 

currently underfunded plans to avoid the underfunding 

premium and additional cash contributions. Financially 

distressed firms are most likely to make maximum use of 

various provisions of law to avoid contributions to plans 

in the period leading up to bankruptcy and also may fail 

to make required contributions. 

Estimates of PBGC’s Shortfall

The Congress is currently weighing policies to improve 

the soundness of the federal pension insurance system. 

The size of PBGC’s prospective shortfall under current 

policy (in other words, not constrained by PBGC’s resources) is key information in this effort, as are estimates 

of the effects of various policy alternatives on prospective 

costs. Although much information about PBGC’s financial condition is publicly available, little is directed at proFirm

Fiscal Year of

Terminationa

Claims

(Billions of dollars)

Number of

Covered

Participants

(Thousands)

Percentage of Total Claims

Over 1975–2004 Period

Bethlehem Steel 2003 3.7 97.0 17.7

LTV Steel 2002, 2003, 2004 1.9 80.4 9.5

National Steel 2003, 2004 1.2 35.4 5.6

Pan American Air 1991, 1992 0.8 37.5 4.1

US Airways Pilots 2003 0.7 7.2 3.5

Weirton Steel 2004 0.7 9.2 3.3

Trans World Airlines 2001 0.7 34.2 3.2

Kaiser Aluminum 2004 0.6 17.6 2.7

Eastern Air Lines 1991 0.6 51.2 2.7

Wheeling Pitt Steel 1986 0.5 22.1 2.4

Total n.a. 11.3 391.5 54.8

11. See U. S. Government Accountability Office, Private Pensions: 

Recent Experiences of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules, GAO-05-294 (May 2005); and Statement 

of Bradley D. Belt, June 15, 2005. 
4 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Table 2.

Obligations and Collections of PBGC’s 

On-Budget Account, 2004

Source: Congressional Budget Office based on information from 

the Pension Benefit Guaranty Corporation and the Office 

of Management and Budget.

a. Includes $10 million of financial assistance to multiemployer 

plans.

b. These transfers are financed with assets from terminated plans 

(and investment income from those assets), all of which are 

held in the off-budget account. The transfers are partial reimbursement to the on-budget account for benefits paid on terminated plans. The proportion reimbursed equals the ratio of 

assets to liabilities in terminated plans.

viding a comprehensive measure of prospective costs and 

their responsiveness to changes in policy.12 

The federal budget, for example, depicts PBGC’s financial performance and prospects in terms of actual or projected cash outflows, for administrative costs and benefit 

payments, and inflows, from premium receipts and transfers from an off-budget account to an on-budget PBGC 

account. For 2004, the federal budget credited PBGC 

with a net cash inflow, or surplus, of $247 million (see 

Table 2).13 (Net inflows are shown as a negative because 

the budget line is labeled “net outlays.”) Thus, from a 

budget-year perspective, PBGC contributed positively to 

the government’s current cash position, despite having assumed more than $3 billion of liabilities from failed steel 

and aluminum companies as well as large prospective 

losses from other large sponsors, such as United Airlines 

and US Airways.

The financial statements prepared by PBGC, by contrast, 

use an accrual basis of accounting that includes several 

more forward-looking measures of liabilities. For 2004, 

those statements indicate that PBGC incurred $12.1 billion more in obligations to others than it acquired in 

claims on others. Further, at year-end, those statements 

show that PBGC had accumulated a negative net position (liabilities exceeded assets) of $23.3 billion (see 

Table 3). The net position includes the present value of 

costs from already terminated plans and probable nearterm terminations but excludes anticipated new claims 

arising in the future.

For measuring prospective shortfalls in the definedbenefit pension system under current and proposed 

changes in law, neither the budget nor the accounting 

measures are especially useful. The budget’s 10-year horizon is generally too short to encompass PBGC’s obligation for plans that terminate within the budget window 

because the bulk of payments will be made over several 

decades. Similarly, the financial statements, while useful 

in identifying unavoidable, or sunk, losses, are mostly 

“backward looking” in that they recognize the effects of 

pension plan terminations that have already occurred or 

that are anticipated in the near term. 

PBGC’s annual report also provides supplemental measures of risk exposure—the total amount of underfunding 

by covered plans, and an estimate of “reasonably possible” 

losses, which represents underfunding in plans sponsored 

by firms whose debt securities are rated below-investment 

grade. At fiscal year-end 2004, total underfunding of all 

insured plans was estimated to be more than $450 billion 

on a termination basis (that is, based on pension liabilities if the plan was to be taken over immediately by 

PBGC), up slightly from the previous year, and “reasonably possible” losses were reported to be $96 billion. 

Millions of Dollars

Obligations

Pension benefits and financial 

assistance 2,883a

Administrative expenses 285

Amount obligated but not 

disbursed -7

Gross outlays 3,161

Collections

Premiums -1,139

Interest -1,206

Transfers from nonbudgetary 

accountb -1,063

Offsetting collections -3,408

Net outlays -247

12. PBGC has developed a model, the Pension Insurance Modeling 

System (PIMS), that projects the future financial condition of 

PBGC under current and alternative policies. See “Impact on 

Contributions, Funded Ratios, and Claims Against the Pension 

Insurance Program of the Administration’s Pension Reform Proposal,” PBGC White Paper (April 6, 2005), available at 

www.pbgc.gov/publications. For additional detail on PIMS, see 

www.pbgc.gov/publications/databook/databk98.pdf. 

13. PBGC is not accounted for on a pure cash basis because assets 

acquired from terminated sponsors are credited to the off-budget 

trust fund (see notes to Table 2). 
THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION 5

Table 3.

Financial Statements for PBGC’s

Single-Employer Program as of

September 30, 2004

Source: Congressional Budget Office based on information from 

the Pension Benefit Guaranty Corporation and the Office 

of Management and Budget.

Note: These statements reflect the transactions of both the onbudget and off-budget accounts.

Finally, PBGC reports a 10-year projected probability 

distribution of its future losses and net position based on 

its Pension Insurance Modeling System. That system generates projections by simulating many future economic 

paths that affect both the financial condition of plan 

sponsors and the underfunding of plans. It also calculates 

distributions of future insurance claims. For 2014, assuming the continuation of current policy, PIMS projects 

a mean net position for PBGC of negative $29.9 billion 

(in other words, an accumulated deficit of that amount). 

That projection implies net new obligations over the next 

10 years of about $6.5 billion. PIMS also assigns a 5 percent probability to a deficit of $60 billion in 2014.14 The 

probability of a positive PBGC net position in 10 years 

was estimated to be 2 percent. 

A Prospective Market-Value Measure

PBGC incurs liabilities when the sponsor of a definedbenefit pension plan is no longer able to fund its pension 

promises—usually because of its own insolvency.15

PBGC then assumes financial responsibility for the plan’s 

guaranteed, unfunded liabilities.16 A sponsor’s financial 

distress and a plan’s level of underfunding17 are, thus, the 

two key determinants of PBGC’s costs. Further, the failure of sponsors and the underfunding of plans are related, 

rather than independent, events. When the pace of economic activity slows, firms’ revenues, stock market values, 

and interest rates all tend to decline. Those changes increase the probability of both financial distress for sponsors and underfunding of pension plans. The more severe 

a downturn, the greater the likely number of failures and 

the extent of underfunding in plans insured by PBGC. 

Billions of 

Dollars

Income Statement

Income

Premiums 1.5

Investments 3.2

Total 4.7

Expenses

Administrative 0.3

Losses from completed and probable 

terminations 14.7

Other net expenses 1.8

Total 16.8 

Net Income -12.1

Balance Sheet

Assets

Cash 7.7

Fixed-maturity securities 17.3

Equities 11.1

Other 2.9

Total 39.0

Liabilities and Net Position

Benefits for terminated plans 43.9

Benefits for probable terminations 16.9

Other 1.5

Total 62.3

Net Position -23.3

14. Those future-value estimates cannot be interpreted as the market 

value of insurance because the calculations do not include risk 

adjustment. Rather, they represent the distribution of values for 

already incurred and probable losses that appear in PBGC’s financial statements. 

15. The terms “insolvency” and “bankruptcy” are used throughout 

this paper to denote events that trigger a transfer of unfunded 

pension obligations to PBGC. That usually occurs after a firm 

enters bankruptcy. However, PBGC does not assume the 

unfunded liabilities of all firms that enter bankruptcy and, conversely, PBGC may assume the unfunded liabilities of firms that 

are distressed but not formally in bankruptcy or liquidation. 

16. Losses on multiemployer plans arise when the plan is unable to 

finance its benefit obligations and PBGC must make loans to the 

plan. The loans are rarely repaid.

17. The term “underfunding” is used here to mean the difference 

between the present value of pension liabilities and pension assets 

when a plan is terminated. Often, as in PBGC’s annual report or 

in corporate financial statements, the term refers to an actuarial or 

accounting difference between assets and liabilities, which can be 

quite different from the present-value calculations that are relevant for estimating PBGC’s costs. See also Appendix B.
6 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

In most years, however, PBGC assumes a relatively small 

number of claims for plan terminations. From 1975 to 

2003, PBGC averaged about 120 termination claims per 

year, with the overwhelming majority consisting of small 

plans.18 PBGC has only assumed 16 plans with more 

than 10,000 participants since 1975, and 11 of those 

have occurred since the stock market decline that began 

in 2000. Nevertheless, PBGC is exposed to the costly but 

low-probability event of the simultaneous bankruptcy of 

a number of large sponsors of defined-benefit plans because of conditions affecting the entire economy.

The Congressional Budget Office (CBO) estimates the 

value of PBGC insurance costs net of expected revenues 

by applying a method widely used by finance practitioners for valuing financial guarantees. Several previous 

studies have taken a similar approach to determining the 

cost of PBGC insurance.19 That technique is especially 

useful for assessing the effects of various policy alternatives in reducing the costs of PBGC insurance. (See 

Appendix C for a more comprehensive description of the 

method.) 

CBO’s Estimates

Net cost is the present value of the unfunded insured liabilities of terminated plans minus the present value of 

premiums received. CBO’s estimates of PBGC’s net costs 

are the sum of backward-looking and forward-looking 

components. The backward-looking component reflects 

the difference between PBGC’s assets and liabilities, inTable 4.

PBGC’s Projected Annual Claims

Source: Congressional Budget Office.

a. Claims for 2004 are actual. CBO’s projection for 2004 was $7.3 

billion, based on year-end 2003 data. The difference between 

projected and actual claims is attributable to several major 

claims projected for 2004 that did not occur until 2005.

b. Claims for 2005 include claims projected for 2004 but realized 

in 2005.

cluding the pension liabilities and pension assets for plans 

that PBGC has assumed or expects to assume in the near 

term. CBO adopts PBGC’s estimate of $23.3 billion for 

the value of past losses as of September 30, 2004. 

The forward-looking component of net costs is the estimated market price to insure all covered benefits of currently operating plans under current premium and funding rules over a specified period. Although losses could 

continue indefinitely under current policy, the uncertainty surrounding estimates increases at longer horizons, 

which is why most of the results are reported for a horizon truncated at 10 years. 

Future annual claims against PBGC (pension plan liabilities minus plan assets for terminated plans) are projected 

to peak in 2005 because of the high level of current underfunding and the low credit quality of several large 

sponsors (see Table 4). After several years, however, projected claims average just above $5 billion per year. 

There is much uncertainty surrounding those numbers, 

arising from uncertainty in levels of underfunding and 

rates of bankruptcy of plan sponsors. From 2004 through 

2008, cumulative claims are expected to amount to about 

$23 billion (undiscounted), but there is more than a 20 

18. Of the approximately 40,000 terminations of defined-benefit 

plans that have occurred since 1983, more than 90 percent have 

been “standard terminations”—those that were fully funded and 

entailed no cost to PBGC.

19. George G. Pennacchi and Christopher M. Lewis, “The Value of 

Pension Benefit Guaranty Corporation Insurance,” Journal of 

Money, Credit, and Banking, vol. 26, no. 3 (August 1994, Part 2), 

pp. 735-753; Su-Jane Hsieh, Andrew Chen, and Kenneth R. Ferris, “The Valuation of PBGC Insurance Using an Option Pricing 

Model,” Journal of Financial and Quantitative Analysis, vol. 29 

(1994), pp. 89-99; and A. Marcus, “Corporate Pension Policy and 

the Value of PBGC Insurance,” Chapter 3 in Issues in Pension Economics, Zvi Bodie, J. Shoven, and D. Wise, eds. (Chicago: University of Chicago Press, 1987). CBO’s analysis extends those studies 

by incorporating more programmatic detail, by accounting for the 

contingent inflow of premiums to PBGC, and by considering a 

larger sample of insured plans and their current financial

status.

Billions of Dollars

2004 3.5a

2005 6.5b

2006 3.7

2007 4.3

2008 4.7

2009 5.0

2010 5.2

2011 5.3

2012 5.3

2013 5.2
THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION 7

percent chance that the total will be less than $8 billion, 

and a corresponding 20 percent chance that the total will 

exceed $25 billion. The cumulative totals from 2004 

through 2014 are larger, because there is more time for 

plans to terminate. Cumulative claims over that period 

are expected to be about $49 billion, but there is more 

than a 40 percent chance that claims will amount to no 

more than $15 billion and a 10 percent chance that 

claims over the period will total more than $120 billion.

Because claims tend to vary with general market conditions, the market is not neutral to uncertainty. Specifically, sponsors are more likely to go bankrupt, and underfunding of plans will be larger, during times of weak 

economic performance; whereas the opposite occurs 

when the economy is strong. The biggest losses will occur 

when the equity markets, wealth, and income are at low 

levels—when money is most valuable. Private investors 

and firms require compensation to assume such market 

risk. That compensation manifests itself in insurance premiums that exceed expected losses discounted at risk-free 

interest rates. In fact, the market value of pension insurance is about twice the value obtained excluding the cost 

of risk (see Table 5).20

Over 10 years, the prospective market-value cost of the 

program is $63.4 billion. Adding PBGC’s accumulated 

deficit of $23.3 billion results in a total cost of $86.7 billion. Extending the horizon increases total net costs to 

$119 billion for the next 15 years and $141.9 billion for 

20 years. 

Comparing those estimates with numbers reported 

in PBGC’s financial statements, the 10-year forwardlooking market value of the insurance is only about 15 

percent of the more than $450 billion in reported aggregate pension underfunding. Two factors explain most of 

that difference. First, bankruptcies occur infrequently. 

Many sponsors will correct their plan’s underfunding over 

time, although funding gaps will also emerge in currently 

funded plans. Eliminating underfunding requires only 

that a firm stay in business long enough for required payTable 5.

PBGC’s Prospective Net Costs for 

Single-Employer Plans Over 10-, 15-, 

and 20-Year Horizons

(Billions of dollars)

Source: Congressional Budget Office.

Notes: Numbers do not include the accumulated deficit

Discounting the average insurance loss at a Treasury rate 

yields the amount that, if invested in Treasury securities 

today, would grow to cover the average of future expenses. 

It is not, however, enough to pay an insurer to cover the cost 

of the entire distribution of future expenses, which is what 

the higher market-value cost represents.

a. Estimated price that a private insurer would charge, in addition 

to current premiums, to accept the obligations arising from terminations over the indicated time period.

ments to restore balance or that the firm realizes high investment returns on pension assets. Second, the average 

excess return on stocks over bonds tends to increase funding levels over time, although at the cost of higher risk 

that increases the severity and cost of losses when they

occur. 

CBO’s $63.4 billion forward-looking net cost estimate is 

far higher than the PBGC’s estimate of $16.9 billion for 

probable losses. An important difference is that CBO’s 

approach includes costs arising from firms that may become financially distressed in the future—not only from 

firms that already are in severe financial distress. At the 

same time, CBO’s estimate is only two-thirds of the $96 

billion in reasonably possible losses reported by PBGC. 

Two offsetting factors help explain the difference between 

CBO’s estimate of prospective net cost and PBGC’s estimates for reasonably possible losses. Reasonably possible 

losses include the entire amount of current underfunding 

of firms with below-investment-grade credit ratings. 

Most of those firms, however, are likely to remain in business long enough to substantially reduce their funding 

20. A similar phenomenon would be observed in a comparison of 

actual stock prices and the expected value of future dividends and 

capital gains, discounted at a risk-free rate. The discounted value 

would far exceed the market price, because the latter includes 

compensation investors require to assume market risk.

Discounted Value at 

Treasury Rates, 

Excluding

Cost of Risk

Market Value, 

Including

Cost of Riska

10-Year Net 

Costs 32.4 63.4

15-Year Net 

Costs 45.8 95.7

20-Year Net 

Costs 55.0 118.6
8 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

gaps. However, the estimate of reasonably possible losses 

neglects the possibility that currently healthy firms will 

become distressed in the future and that the losses from 

currently troubled firms may grow larger. 

Options to Reduce Federal Costs

In general, policy alternatives that reduce PBGC’s exposure require imposing greater costs on plan sponsors and, 

indirectly, on beneficiaries. Sufficiently large changes 

would probably result in behavioral responses by sponsors 

or beneficiaries. However, the estimates discussed here do 

not incorporate such responses.

Options to place the costs of insurance more fully on 

sponsors and thus limit federal exposure fall into two 

broad categories: increases in the premiums charged to 

plan sponsors, and tighter investment and accounting 

rules for funding pension plans. The options that involve 

premium increases reduce the cost to the government but 

have little effect on its risk exposure. The second set of 

options would reduce costs by reducing the risk of underfunding. All of the options would raise the cost to employers of offering defined-benefit plans. 

Changing Premiums

More than a decade ago, the Congress set annual insurance premiums to the PBGC at $19 per participant plus 

$9 per $1,000 of unfunded, vested benefits for singleemployer plans. Since then, rates of insolvency by sponsors have increased, inflation has eroded the real value of 

premiums, and underfunding has become more prevalent. Accordingly, the Congress is considering increasing 

premiums.21 One possibility is to adopt an actuarially fair 

premium structure—that is, one that would equate the 

present value of expected premium revenues with the 

present value of expected costs to PBGC. Many alternative premium structures, however, would be broadly consistent with actuarial fairness, including a uniform premium that does not vary according to sponsor or plan 

characteristics and risk-based premiums that reflect risk 

differentials among sponsors or plans. 

Both uniform and risk-based fair premiums raise the 

question of whether it is desirable to cover costs arising 

from the current level of underfunding or whether premium charges should be entirely focused on prospective 

shortfalls. In the latter case, additional monies probably 

would be required to cover the portion of future losses 

arising from current underfunding. Those funds could be 

obtained either from government revenues or from supplemental assessments on the sponsors of underfunded 

plans. 

Conceptually and practically, the prospective approach 

has several advantages. The idea of a fair insurance premium is intrinsically forward-looking: it is the expected 

cost of future adverse outcomes covered under the terms 

of the insurance policy. Setting uniform premiums to 

cover losses arising from current levels of underfunding 

requires fully funded plans to subsidize underfunded 

plans. That would tend to discourage low-risk firms from 

continuing to offer defined-benefit plans, weakening the 

system further by hastening the withdrawal of financially 

stable participants. Covering already-incurred costs with 

future premium revenues also involves partially doublecharging for insurance. Sponsors that in the past paid required premiums and followed pension funding rules but 

nevertheless are currently underfunded because of 

changes in economic circumstances have already been 

charged for the risks associated with that eventuality. 

A policy of charging a fair prospective premium does not 

preclude the possibility of requiring sponsors to make additional payments based on their current underfunding, 

as occurs under current law through deficit reduction 

contributions (DRCs). Currently, sponsors of plans that 

are funded to less than 90 percent of current liabilities are 

required to close funding gaps in excess of a threshold in 

approximately three years. Tightening DRC rules to require deficits to be covered more quickly and fully, for instance, would tend to reduce risk to PBGC and in turn 

would lower the fair premium rate.22

Fair Uniform Premiums. CBO estimates that a fair uniform premium—one that increases both the fixed and 

variable portion of current-law premiums by a fixed proportion—would yield premium charges that are 6.5 times 

larger than current rates, with a fixed payment of 

$123.50 per participant per year and a variable charge of 

$58.50 per $1,000 of underfunding. Although such a 

rate hike is likely to cause a reduction in the number of 

plans offered, it is difficult to predict how large that effect 

would be, and no behavioral response is incorporated 

21. The Administration has proposed increasing the fixed perparticipant premium to $30 per year.22. If sponsors are required to close gaps in funding too quickly, they 

may choose to discontinue offering workers this benefit. 
THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION 9

into the model. Even though a 6.5-fold increase is a large 

multiple, in dollar terms it corresponds to an increased 

fixed charge of only about $105 per employee per year. 

The higher variable portion, however, could be very 

costly for plans that become underfunded. It would provide an incentive to make up the shortfall more quickly 

but also could lead firms to eliminate that risk in the future by dropping the defined-benefit plans. 

The Congress is also considering more modest proposals 

for increasing the current level of premiums while retaining the existing structure. For example, increasing the 

flat-rate premium from $19 per participant per year to 

$30 per participant would reduce PBGC’s net cost by 

about $1.8 billion over a 10-year horizon (see Table 6).

Risk-Based Premiums. In addition to the variable premiums that severely underfunded plans now pay, a premium 

schedule that reflects sponsor- and plan-risk characteristics could reduce the incentives for excessive risk-taking 

and reward prudent behavior. It also could reduce crosssubsidies among firms, thereby mitigating the incentive 

for low-cost firms to leave the system. Some indicators of 

risk that could be used for risk-adjusting premiums include the equity-bond mix of pension assets, a sponsor’s 

debt rating or leverage, and the value of insured benefits.

Pension Asset Risk. Under current law, firms are permitted 

to invest the majority of their pension assets in stocks and 

other risky securities, even though the pension liabilities 

they are financing have cash flows that are more similar to 

bonds. The resulting mismatch is one of the principal 

reasons that pension plans, including those sponsored by 

financially healthy firms, become underfunded during 

periods of falling stock prices. In addition, PBGC is subject to moral hazard, which is the tendency of those who 

have insurance to engage in riskier behavior than they 

would if they did not have insurance. Sponsors of 

defined-benefit pensions are under less pressure from participants and hence have weaker incentives to fully fund 

those plans with low-risk assets as a result of PBGC insurance. In addition, financially distressed plan sponsors 

whose survival is threatened have a strong incentive to invest in high-risk pension assets. The potential gains from 

such investments accrue to the sponsor via lower required 

contributions and may enable it to survive, whereas potential losses will be absorbed by PBGC if the firm fails.

One option that would encourage firms to limit risk in 

their pension assets would be to link premiums to the 

Table 6.

Estimated Effects of Selected Policy 

Changes on PBGC’s Net Costs for

Single-Employer Plans Over Ten Years

(Billions of dollars)

Source: Congressional Budget Office.

a. Estimated price that a private insurer would charge, in addition 

to current premiums, to accept the obligations arising from 

terminations over 10 years.

share of pension assets held in stocks and other risky 

investments. Such a premium also could reduce crosssubsidies among sponsors by matching premiums more 

closely with expected costs. A premium change that induced firms to reduce the share of pension assets held in 

stocks to 30 percent from the current level of about 70 

percent would reduce PBGC’s net cost over 10 years by 

$9.9 billion (see Table 6).23

Market Valuea

PBGC’s Prospective Net Costs Over 10 

Years Under Current Law

63.4

Effect of Policy Change 

Increase annual premium 6.5 times -63.4

Increase flat-rate premium to $30 

for all plans

-1.8

Increase flat-rate premium from $19 

per participant to $30 for plans 

funded at 100 percent or more, $40 

for plans funded at 90 percent to 

less than 100 percent, and $60 for 

plans funded at less than 90 percent

-3.9

Require all underfunded plans to pay 

the variable-rate premium

-0.9

Limit a pension plan’s investments in 

equities to 30 percent of plan assets

-9.9

Increase the period over which 

underfunding is corrected by two 

years

3.4

Make permanent the increase in 

discount rates for calculating pension liabilities

8.1

23. The reduction in net cost excludes any change in premium 

income that might accompany the changed premium structure.
10 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Sponsor Credit Risk. Risk-adjusted premiums might also 

be based on observable sponsor attributes such as its 

credit rating or an alternative measure of default risk. 

Charging a rate partially based on credit risk would reduce the extent to which less-risky firms subsidized riskier 

firms. Such risk adjustment may have little influence on 

risk-taking, however, because the premium is a relatively 

unimportant factor in firms’ decisions about their line of 

business or debt structure.

Historically, the 10-year default probability for 

investment-grade firms is 2.7 percent, but it rises to 

28.3 percent for below-investment-grade firms.24 To 

quantify the cost differential associated with the higher 

default probability, rated firms are divided into two broad 

categories: investment grade (BBB and above) and noninvestment grade (below BBB).25 CBO’s analysis indicates 

that premiums for below-investment-grade firms would 

need to be increased 18.5 times just to reduce net cost per 

dollar of insured benefits to the cost for investment-grade

sponsors. 

Charging a fair rate to high-risk firms may be impractical, 

however, because once a firm’s financial condition deteriorates, it may be too late to collect premiums sufficient to 

cover the firm’s increased costs to PBGC. Thus, as with 

most insurance, most costs must be covered prospectively.

Insured Benefits. The current policy of basing the fixed 

portion of the premium on the number of plan participants rather than the dollar value of insured benefits is 

another factor that disconnects premium charges from 

plan risk. That is because PBGC’s exposure is related to 

the size of the covered liability, which varies considerably 

among participants and with the extent to which the plan 

is underfunded. Young and low-wage workers have low 

accumulated benefits, whereas older and more highly 

compensated workers and retirees have larger insured 

benefits. Consequently, a level premium tends to favor 

firms with many retirees or older workers at the expense 

of firms with predominantly young workers. Basing the 

premium instead on insured benefits would make employers’ costs more closely reflect risk as well as reduce 

cross-subsidies and the disincentive for firms with newer 

employees to offer defined-benefit pensions.

The magnitude of the effect of the per-participant component can be demonstrated by dividing the current flatrate premium by the amount in dollars of insured coverage for each firm in CBO’s sample. The indicated range 

of premiums paid per dollar of insured coverage among 

sponsors is striking. The highest 10 percent of firms, in 

terms of coverage per worker, pay an average of 0.6 percent of the pension-benefit obligation, whereas the lowest 

10 percent of firms pay 2.3 percent of the pension-benefit 

obligation. The fraction of retirees relative to total participants in each firm explains a considerable amount of that 

variation, with a strong negative correlation (-0.4) between the fraction of retirees and the premium per dollar 

of pension-benefit obligation. That finding suggests that 

one reason for the decline in defined-benefit-plan offerings among newer firms may be the policy of charging a 

flat premium per participant. 

Regulating Pension-Investment Risk

Although some firms might be induced to reduce the 

share of pension assets invested in stocks by risk-based 

premiums that are sensitive to portfolio risk, some observers have recommended that firms should simply be 

required to fund their pension liabilities with a higher 

proportion of investment-grade bonds, whose cash inflows would closely match the outflow of pension benefits.26 Such a requirement might be more effective than 

risk-based premiums, especially for sponsors that are financially troubled and for whom moderately higher premiums might not be much of a deterrent to risk-taking. 

PBGC has taken steps to reduce risk in its own portfolio 

by better matching the risk of assets and liabilities, and it 

expects the portion of invested assets allocated to equities 

to decline to between 15 percent and 25 percent of total 

invested assets over the next two years. A similar mix 

could be required of private firms. For example, reducing 

the share of stocks in pension assets from the current average of 70 percent to 30 percent would reduce the market value of PBGC’s insurance by $9.9 billion. 

24. Standard & Poor’s, “Annual Default Study: Corporate Defaults 

Poised to Rise in 2005,” Global Fixed Income Research (2005), 

p. 17, Table 10.

25. Credit ratings are available for a subset of 678 of the 1,179 firms 

for which CBO has data.

26. Zvi Bodie, “Straight Talk About Government Pension Insurance,” 

Milken Institute Review, vol. 7, no. 1 (2005). 
THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION 11

Changing the Rules for Calculating Pension

Liabilities 

Another major source of cost and risk to PBGC arises 

from the large discrepancies that sometimes occur between a best estimate of the true economic liabilities of a 

pension plan and the current-liabilities measure that determines required funding.27 Under existing rules and 

depending on market conditions, plan liabilities may be 

under- or over-stated, and plans may be commensurately 

over- or underfunded relative to an economic measure of 

the funding gap.28 (See Appendix B for a discussion of 

funding measures.)

Several factors make estimates of current liabilities poor 

proxies for true economic liabilities: projections of future 

benefit payments are downward-biased relative to 

PBGC’s expected obligations in the event of a distress

termination; and the rate used to discount future cash 

flows is not a current market rate and neglects that the 

market assigns different rates to cash flows with different 

maturities.

Even plans that are close to fully funded by current measures often have large gaps between measured and actual 

liabilities when they are terminated.29 Two illustrative 

cases are the plans for employees of Bethlehem Steel and 

the pilots of US Airways, both of which reported high 

funding levels in the years immediately prior to their termination, when their funding levels were determined to 

be less than 50 percent (see Table 7). A feature of some 

plans that inflates termination liabilities over current liabilities is the presence of shutdown benefits. Shutdown 

benefits are triggered by the shutdown of one or more 

plants within a company or by permanent layoffs within 

a firm, and those benefits qualify workers for retirement 

as early as age 42. PBGC is responsible for paying shutdown benefits if they are triggered before a plan is terminated, but the benefits are not recognized as liabilities 

before they are triggered. Such benefits, however, are 

common only in large unionized manufacturing companies and account for only a small portion of realized costs.

In CBO’s analysis, the difference between current and 

termination liabilities is a large component of PBGC’s 

net costs. That is because current liabilities, which determine whether a plan is fully funded, are systematically 

lower than termination liabilities, which more closely reflect the cost to PBGC in the event of a plan’s termination. Adjusting liabilities to better reflect costs in the 

event of a termination could reduce the high cost of systematic underfunding under current rules. However, requiring low-risk sponsors to fund to the level of termination liabilities would result in systematic overfunding, 

since most plans do not fail. 

Another shortcoming of the current measure of a plan’s 

liabilities is that discount rates are backward-looking: 

vested pension benefits are discounted at a four-year 

weighted average of past interest rates. A change requiring 

the use of current market rates matched to the maturity 

of cash flows for discounting pension liabilities would 

provide a more accurate and timely picture of PBGC’s exposure and bring the estimates more in line with standard 

valuation practices. Some sponsors of defined-benefit 

plans have opposed the use of current interest rates to calculate pension liabilities because it would increase the 

volatility of funding requirements. However, funding requirements could be modified to reduce the variability 

caused by more timely and accurate estimation of current 

liabilities without sacrificing correct valuation.

There is considerable disagreement about the appropriate 

discount rate to use in calculating pension liabilities for 

the purpose of determining funding requirements. Proponents of using a long-term Treasury bond rate argue 

that the guaranteed benefits are virtually risk-free, and 

hence that rate is appropriately conservative. Others argue that the use of a risk-free rate is inappropriate because 

the obligations are not risk-free (for instance, they depend on future wages that are risky) and that using a 

Treasury rate results in inflated liability values. Previously, 

an average of rates for 30-year Treasury securities had

27. The rules for calculating pension assets and liabilities are complex 

and differ according to whether the quantities are for financialreporting purposes, for determining pension funding obligations, 

or for calculating the variable-rate premium. See U.S. Government Accountability Office, Private Pensions: Recent Experiences of 

Large Defined Benefit Plans.

28. Valuation distortions tend to be smaller on the asset side because 

market values are used for most investments. Still, rules that allow 

for smoothing estimated asset values also reduce the accuracy of 

funding-gap calculations.

29. In part because of interest rate distortions—other factors including those pertaining to shutdown benefits, early retirement, and 

lump-sum distributions also play a role—PBGC officials have 

argued that current liability is “a measure with no obvious relationship to the amount of money needed to pay all benefit liabilities if the plan terminates.” Testimony of Bradley D. Belt, 

Executive Director, Pension Benefit Guaranty Corporation, before 

the Senate Committee on Finance, March 1, 2005.
12 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Table 7.

Reported Funding Levels and Premium Payments for the Bethlehem Steel and 

US Airways Pilots’ Plans, 1996 to 2002

Source: Congressional Budget Office based on information from the Pension Benefit Guaranty Corporation.

Notes: Bethlehem Steel’s plan was terminated in 2003. It had a termination funding ratio of 45 percent and unfunded benefit liabilities of 

$4.3 billion, of which PBGC is responsible for $3.7 billion. US Airways pilots’ plan was also terminated in 2003. It had a termination 

funding ratio of 35 percent and unfunded benefit liabilities of $2.2 billion, of which PBGC is responsible for about $700 million.

NR = not reported.

been used, but the Pension Funding Equity Act of 2004 

substituted indexes of rates on high-grade corporate 

bonds for years 2004-2005 (that temporary change is reflected in all cost estimates reported in this paper). The 

law further permits plan sponsors to choose a discount 

rate between 100 percent and 90 percent of the designated rate, but the higher rate is usually chosen. 

The policy option analyzed here is to make the currently 

temporary switch from a 30-year Treasury bond rate to a 

high-grade corporate bond rate permanent after 2005. 

The effect of any increase in the assumed discount rate 

for liabilities is to increase PBGC’s costs, because such an 

increase results in firms’ holding fewer pension assets.

To project the effect of a switch to the corporate rate, 

CBO adjusted pension liabilities downward by multiplying by the ratio of two annuity factors implied by the old 

and new discount rates. Typically, a high-grade, longterm bond yields 1 percent to 2 percent more than a 30-

year Treasury bond. Projected cash flows from premiums 

and deficit reduction contributions are then based on the 

lower liabilities.30 Liabilities are assumed to be at their 

original level, however, for the purpose of computing the 

cost to PBGC at the time a plan is terminated. That assumption captures the idea that increasing the discount 

rate reduces required payments but has no effect on the 

actual costs of future obligations. 

The result of this analysis indicates that a permanent increase in the discount rate from 4.8 percent to 6 percent 

would cost PBGC about $8.1 billion (see Table 8). That 

result is consistent with the general point that a higher 

rate always leads to a lower present value of obligations, 

which in turn leads to commensurately lower estimates of 

underfunding, deficit reduction contributions, and variable premiums. Hence, a higher discount rate lowers the 

current-period cost to plan sponsors but increases the risk 

exposure of PBGC. The incremental cost increase gets 

1996 1997 1998 1999 2000 2001 2002

Current Liability Funding Ratio (Percent)

Bethlehem 78 91 99 96 86 84 NR

US Airways 97 100 91 85 104 94 NR

Was the Company Required to Make a Deficit Reduction Contribution?

Bethlehem Yes No No No No NR NR

US Airways No No No No No No NR

Variable-Rate Premium Payments

Bethlehem $15 million $17 million 00000

US Airways $4 million 0 0 0 $2 million 0 0

Contributions to the Retirement Plan

Bethlehem $354 million $32 million $31 million $8 million 0 0 0

US Airways $112 million 0 $45 million 0000

30. The original liability of each firm is assumed to be a 20-year annuity, originally discounted at a rate of 4.8 percent. The value of the 

liability is adjusted by the ratio of the original discount rate to the 

new, higher rate.
THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION 13

Table 8.

Net Cost to PBGC of a Permanently 

Higher Discount Rate

Source: Congressional Budget Office.

smaller as the discount rate rises further because, at some 

point, few firms appear to be underfunded, and sponsor 

payments decline no further. The largest costs from basing liabilities on an artificially high discount rate come 

from heavily underfunded firms, which benefit from a 

large cutback in deficit reduction contributions and the 

deficit-based component of the premium.

Options to Increase Transparency

To understand and control PBGC’s risk exposure, policymakers must be able to monitor the financial performance and condition of the defined-benefit insurance 

system and of PBGC. To that end, PBGC’s annual report 

includes extensive information about the financial status 

of defined-benefit plans as well as the position of PBGC 

as a result of losses incurred to date. However, the Congress primarily relies on budget estimates for information 

about the cost of current and alternative policies. To assure that those estimates are appropriately prospective 

and accurate, the budget may need to become more comprehensive in recognizing PBGC’s transactions and committed obligations. To that end, the Congress may wish 

to consider extending the use of accrual measures to the 

budgetary accounting for PBGC. Further, privatization 

could illuminate the costs that the government incurs by 

requiring payments to private providers of insurance.

Alternative Budgetary Treatments 

The budget currently includes three types of financial information about PBGC: cash flows that are included in 

budget outlays and the deficit, cash and noncash financial 

flows that are excluded from the budget totals, and supplementary accounting information in the form of balance sheets for PBGC. Budget outlays and the deficit include those cash inflows and outflows that are accounted 

for in PBGC’s on-budget fund. That account is charged 

with benefit payments for terminated plans and administrative expenses. It is credited with premium receipts, interest on investments in Treasury securities held by the 

on-budget fund, and transfers from PBGC’s off-budget 

trust fund (see Table 2 on page 4). 

The transactions of the off-budget trust fund, including 

the acquisition of assets and liabilities of terminated plans 

(net claims), are reported in the budget’s supplementary 

disclosures but are not included in the budget totals when 

the transactions of the off-budget fund occur. That practice delays recognition of losses, often for decades, until 

benefits are paid. At the same time, premiums and transfers to the on-budget account from the off-budget account are recognized as received. As a consequence, and 

despite large prospective losses from underfunded terminated plans, PBGC transactions have usually reduced total budget outlays and the federal deficit. In fact, the budget recorded its first annual net cash outflow for PBGC in 

2003 of $229 million. For fiscal year 2004, net budget 

outlays for PBGC were once again negative, representing 

a net cash inflow. Thus, net budget outlays for PBGC are 

not indicative of the financial position of the insurance 

program. 

A key measure of financial performance for an insurance 

program—currently omitted from both financial and 

budgetary accounting—is the expected cost of future 

claims, net of expected future premiums. To more accurately report the cost of current transactions, some deferred payment programs are currently accounted for in 

the budget on an accrual basis. Those include direct 

loans, loan guarantees, and capital leases. A credit guarantee is a form of insurance. Thus, the logic for putting 

credit guarantees on an accrual basis may apply equally to

insurance. 

Treating PBGC as a Trust Fund. Before considering accrual budget measures for PBGC, the Congress may wish 

to address the more fundamental issue of whether federal 

pension insurance gives rise to a federal obligation. Under 

current law, neither PBGC nor insured pension beneficiaries have a claim on federal funds to make up a financial shortfall between insured benefits and PBGC’s accumulated assets. If, on the one hand, the Congress intends 

to maintain that limit on federal liability, then the income and assets of PBGC could be reclassified as trust 

funds—amounts owned by others and held for their exclusive benefit by the government. In that case, it would 

Long-Term Discount Rate

(Percent)

Cost Increase

Compared with a

4.8 Percent Rate

(Billions of Dollars)

6.0 8.1

7.0 14.5

8.0 19.2
14 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

be consistent with current budget concepts to take the 

on-budget account off-budget. If premiums are considered compulsory governmental levies that are earmarked 

for pension insurance, those collections could be credited 

to an on-budget account and immediately paid out to the 

off-budget trust account. That treatment would include 

premiums in governmental revenues but bar their inclusion in the budget deficit or surplus. Further reflecting 

the governmental status of PBGC, the cost of administering the program could be paid from the on-budget account and financed by either insurance premiums or a 

general-fund appropriation. 

Accruing PBGC’s Cost. If, on the other hand, the Congress 

provided an explicit guarantee of federal pension insurance, then it could consider accruing increases in PBGC’s 

shortfall in the budget. To that end, the valuation methods developed by CBO and described in more detail in 

Appendix C could be used to estimate a periodic accrual 

cost of PBGC pension insurance—the change in PBGC’s 

total net value per period—on a market-value basis. 

Thus, one policy option is to substitute that charge for 

the current budgetary measure of net outlays. Other possible accrual changes include the unpaid annual premium 

that would be required to reduce PBGC’s cost to zero.

Recognizing an accrual charge for PBGC in the budget 

would require periodic appropriations to and transfers 

from PBGC that correspond to the change in the value of 

the insurance. That is, PBGC’s annual increase (or decrease) in total costs would be financed (or liquidated) by 

an appropriation from (or payment to) the general fund 

of the Treasury. Those transfers could be reflected in the 

budget deficit by paying appropriated sums for losses to 

the off-budget trust account and by requiring a reverse 

flow from the trust account to the on-budget PBGC account in the event of a trust fund surplus. To prevent the 

cost of risk—currently borne by taxpayers without recognition in the budget—from accumulating in PBGC’s 

trust account, PBGC could also make a payment to the 

Treasury’s general fund for the cost of risk.

Accounting for Sunk Costs and Reserve Accumulation.

Accrual budgetary treatment of PBGC, like cash accounting, would fail to fund past or sunk PBGC losses. Those 

losses might be financed with a one-time catch-up appropriation to PBGC’s trust fund for the accumulated deficit. Inasmuch as those losses were incurred in previous 

periods, they could be treated to leave the budget totals 

for the current year unaffected by legislation that provides 

their financing.

Privatization

Another option that might facilitate control of PBGC’s 

costs would be to transfer the agency to private owners or 

to replace it with private policies purchased by sponsors 

from competing private insurers. Privatization could accelerate the recognition of past losses in the budget because the current deficit would have to be reduced, presumably by Congressional appropriations, before a 

private entity would be willing to assume the program’s 

obligations. Because PBGC insurance is mandatory, the 

government would probably remain involved in regulating the terms of the insurance. That continued involvement raises the question of how much risk and responsibility the government effectively can transfer to private 

providers. Nevertheless, the risk to the government would 

most likely be less than under current policy. 
Appendix A: The Pension Benefit Guaranty Corporation’s Financial Data: Single-Employer and Multiemployer Programs

A

The Pension Benefit Guaranty Corporation’s

Financial Data: Single-Employer

and Multiemployer Programs

The Pension Benefit Guaranty Corporation publishes financial statements for each fiscal year in a Performance and Accountability Report as required by the Office 

of Management and Budget’s Circular No. A-11. The report includes sections titled Management’s Discussion 

and Analysis of Financial Condition and Results of Operations; Statements of Financial Condition, Operations 

and Changes in Net Position, and Cash Flows; and extensive explanatory Notes. Those reports are available at 

www.pbgc.gov/docs. Reported assets, liabilities, and net 

position for the single-employer and multiemployer programs are provided here for 1980 through 2004 (see 

Table A-1).

APPENDIX
16 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Table A-1.

PBGC’s Assets, Liabilities, and Net Financial Position for Single-Employer and 

Multiemployer Plans, 1980 to 2004

(Millions of dollars)

Source: Congressional Budget Office based on Pension Benefit Guaranty Corporation, Annual Reports (1980–2004).

a. The deficit of $3.8 billion that was originally reported for 1986 declined after a Supreme Court ruling restored three pension plans and 

returned their pension obligations of $1.8 billion to LTV Corporation.

Single-Employer Plans Multiemployer Plans Combined

Assets Liabilities Net Position Assets Liabilities Net Position Net Position

1980 430 524 -95 21 30 -9 -104

1981 467 656 -189 28 29 -1 -190

1982 773 1,106 -333 40 29 11 -322

1983 1,085 1,608 -523 52 46 6 -517

1984 1,063 1,525 -462 61 44 17 -445

1985 1,155 2,480 -1,325 78 52 27 -1,298

1986 1,740 3,766 a -2,026a 98 54 45 -1,981

1987 2,163 3,712 -1,549 114 45 68 -1,481

1988 2,422 3,965 -1,543 129 37 92 -1,451

1989 3,059 4,183 -1,124 161 37 123 -1,001

1990 2,797 4,710 -1,913 190 58 132 -1,781

1991 5,422 7,925 -2,503 238 75 163 -2,340

1992 6,381 9,118 -2,737 283 114 169 -2,568

1993 8,267 11,164 -2,897 407 131 276 -2,621

1994 8,281 9,521 -1,240 378 181 197 -1,043

1995 10,371 10,686 -315 477 285 192 -123

1996 12,043 11,174 869 505 381 124 993

1997 15,314 11,833 3,481 596 377 219 3,700

1998 17,631 12,619 5,012 745 404 341 5,353

1999 18,431 11,393 7,038 692 493 199 7,237

2000 20,830 11,126 9,704 694 427 267 9,971

2001 21,768 14,036 7,732 807 691 116 7,848

2002 25,430 29,068 -3,638 944 786 158 -3,480

2003 34,016 45,254 -11,238 1,000 1,261 -261 -11,499

2004 38,993 62,298 -23,305 1,070 1,306 -236 -23,541
Appendix B: Accounting and Funding Measures of Firms’ Pension Liabilities and Underfunding

B

Accounting and Funding Measures of

Firms’ Pension Liabilities and Underfunding

A firm’s pension liability is the present value, on 

the reporting date, of promised future benefit payments. 

However, pension liabilities are measured in different 

ways for different purposes. For reporting purposes, liabilities are measured according to accounting rules set by 

the Financial Accounting Standards Board, but for determining funding levels, they are measured according to 

the rules set by the Employee Retirement Income Security Act or the Internal Revenue Code. Further, because 

underfunding is the difference between pension liabilities 

and assets, the degree to which a plan is funded varies according to whether the funding or accounting measures 

are used. 

The accounting measures used in a firm’s financial statements and 10-K filings to the Securities and Exchange 

Commission are the accumulated benefit obligation 

(ABO) and the projected benefit obligation (PBO). The 

ABO is based on the number of active workers, retirees, 

and beneficiaries in the pension plans; current pay; and 

length of service. The firm chooses a discount rate to apply to future benefits based on a market rate for longterm securities. The PBO differs from the ABO in that it 

also includes provisions for assumed future wage growth 

for active workers. Both measures are highly sensitive to 

actuarial and economic assumptions, which are not consistent among firms. Accounting rules also require firms 

to recognize a liability on their balance sheets when pension assets are less than the ABO, and many firms choose 

to fully fund to the reported ABO rather than recognize 

the additional liability.

The funding rules, however, refer to current liability and 

termination liability. Current liability is conceptually 

similar to ABO, but may differ from the ABO in the actuarial assumptions and discount rates that it uses. Further, there are different measures of current liability that 

use different discount rates depending on the funding 

rule that is being applied. For example, the current liability used to determine whether deficit reduction contribution (DRC) payments are required may reflect a discount 

rate that differs from that used for determining whether 

variable-rate premiums are required. 

Termination liability applies when plans are terminated. 

It differs from ABO and current liabilities in that it includes the higher costs of early retirement, lump-sum distributions, and skipped contributions by financially distressed firms prior to a plan’s termination. Termination 

liability also differs from ABO and current liabilities because it uses different assumptions about discount and 

mortality rates. 

Several of these factors have been important in recent terminations. For example, US Airways made no contributions to its pension plan for pilots for four years prior to 

the plan’s termination in March 2003 with $2.2 billion in 

unfunded benefits, and United Airlines recently announced it would forgo paying several billion dollars in 

required contributions. The Pension Funding Equity Act 

of 2004 placed a two-year moratorium on deficit reduction contributions by the passenger airlines, iron ore pellet, and steel industries. In addition, impending bankruptcy can lead to a higher rate of early retirement, and 

firms also may substitute benefit promises—that, after 

bankruptcy, they would not have to fulfill—for higher 

wages. The overall effect of those factors can be large. For 

instance, in its last filing, Bethlehem Steel reported that it 

was funded at 84 percent of current liabilities. On a termination liability basis, it was funded at only 45 percent, 

with underfunding of about $4.3 billion. 

APPENDIX
18 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

For modeling purposes, the Congressional Budget Office 

(CBO) uses the ABO reported in company financial 

statements as the best publicly available approximation of 

current liability for calculating both DRC requirements 

and variable rate premiums.1 Because CBO lacks detailed 

information about termination liabilities, it follows past 

studies and increases current liabilities by 20 percent to 

approximate termination liabilities. That assumed 

markup is necessary to account for the increase in promised benefits as a firm approaches insolvency or, more 

generally, the difference between the liability realized at 

termination and the reported current liability. 

1. Current liabilities are reported by firms on Internal Revenue Service Form 5500 but are only available with a lag of two or more 

years.
Appendix C: The Congressional Budget Office’s Pricing Model for the Pension Benefit Guaranty Corporation

C

The Congressional Budget Office’s

Pricing Model for the

Pension Benefit Guaranty Corporation

The Congressional Budget Office’s (CBO’s) pricing 

model estimates how much a private insurer would 

charge to assume the unfunded obligations of the Pension 

Benefit Guaranty Corporation (PBGC) over a specified 

time horizon. PBGC is liable for a company’s pension obligations only if the company is bankrupt and if dedicated 

pension assets fall short of the value needed to cover 

vested pension obligations.1

 That is, the plan can be significantly underfunded with no ultimate cost to PBGC if 

the plan’s assets increase to cover the liabilities before the 

firm fails. Conversely, fully funded or overfunded plans 

still represent a risk to PBGC because future declines in a 

plan’s asset value or increases in liability value can cause it 

to become underfunded. CBO’s valuation model, which 

values the agency’s insurance as a financial option, takes 

those factors into account in estimating the prospective 

cost of insurance. 

The general idea behind options-pricing methods is that 

assets with the same payoffs must have the same price. 

Thus, it is possible to infer the price of an option—in this 

case, PBGC’s guarantee—from the price of a portfolio of 

assets that has the same payoff as the guarantee.2

 The valuation model employs a stochastic simulation3

 that 

projects the evolution of:

B The sponsor’s assets and book value of liabilities in order to assess the likelihood of insolvency, which occurs 

when the value of assets falls sufficiently below the 

value of liabilities;

B Pension plan assets relative to benefit obligations in 

order to estimate the shortfall for terminated plans; 

and

B Projected premium payments to PBGC, contingent 

on the projected level of pension plan funding and 

whether the firm is solvent.

With those building blocks, CBO calculates a probability 

distribution of insurance losses to PBGC at each future 

date. The cost of PBGC insurance is the present value of 

those expected losses, calculated using risk-adjusted discount rates—rates that vary according to the severity of 

market risk along each simulated time path. Premiums 

are similarly discounted using risk-adjusted rates. The 

difference between the present value of insurance and the 

present value of premiums received is the market value of 

the insurance obligation, or the cost of the potential liability to the government if it were to cover PBGC’s shortfalls from future losses. 

APPENDIX

1. PBGC may, but rarely does, assume a plan’s liabilities when pension assets fall to sufficiently low levels, even though the firm 

remains solvent. That can be costly to the firm because PBGC will 

file a claim against the firm for all of the plan’s underfunding, not 

just for the portion of underfunding that the agency guarantees.

2. See, for example, Robert L. McDonald, Derivatives Markets (New 

York: Addison-Wesley, 2003), Chapter 10.

3. To accommodate the compound option and the detailed program 

rules, the options-pricing model is solved using a Monte Carlo 

simulation. 
20 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Table C-1.

Sources and Uses of Data for CBO’s Model

Source: Congressional Budget Office.

Note: S&P = Standard & Poor’s; GICS = Global Industry Classification System; IRS = Internal Revenue Service.

Variable Source Additional Notes

Assets

Initial Market Value of Firm Assets Model generated

Firm Asset Volatility Model generated Idiosyncratic risk bounded between 5% and 50%

Industry Asset Beta http://pages.stern.nyu.edu/~adamodar/ To determine the expected return on firm assets 

and to set boundaries on asset volatility 

estimates

Equity

Equity Dividend Yield S&P Compustat

Market Value of Equity S&P Compustat To convert the equity dividend yield into an asset 

dividend yield

Liabilities

Long-Term Debt Category S&P Compustat Broad rating categories (that is, without modifiers)

Industry Average Debt Ratio S&P Compustat S&P’s GICS Group determines the industry 

classification

Pensions

Initial Value of Pension Assets S&P Compustat

Initial Value of Pension Liabilities S&P Compustat The accumulated benefit obligation approximates 

the current liability; used to determine funding 

requirements

Plan Participants IRS Form 5500 Number of pension plan participants

Requirements for the Model Used to Determine the Initial Market Value and Volatility of Firm Assets

Market Value of Equity S&P Compustat

Equity Volatility http://pages.stern.nyu.edu/~adamodar/

Initial Book Value of Liabilities S&P Compustat

Weighted Average Maturity of Firm Debt S&P Compustat
APPENDIX C THE CONGRESSIONAL BUDGET OFFICE’S PRICING MODEL FOR THE PENSION BENEFIT GUARANTY CORPORATION 21

Table C-2.

Assumptions of CBO’s Model

Source: Congressional Budget Office.

Note: IRS = Internal Revenue Service.

Parameter Value Additional Notes

Stock Weight in Pension Portfolio 70% 

Stock Market Beta 1.0

Bond Market Beta 0.1

Pension Asset Beta 0.73 Derived from the stock weight in the pension portfolio and assumed 

stock and bond betas

Risk-Free Rate 3.5%

Expected Return on Stock Market 7.0%

Expected Return on Firm Assets Variable Derived from the industry asset beta, risk-free rate, and stock market 

expected return

Expected Return on Pension Assets 6.1% Derived from the pension asset beta, risk-free rate, and stock market 

expected return

Stock Market Volatility 18%

Pension Asset Idiosyncratic Risk 0

Pension Asset Volatility 13.1% Derived from the pension asset beta, stock market volatility, and 

pension asset idiosyncratic risk

Recovery Rate on Failed Pension Plans 7%

Interest Rate on Firm Debt Variable Risk-free rate (rf) for firms rated A and higher, rf + 1.5% for firms 

rated BBB and nonrated firms, and rf + 2.1% for non-investmentgrade firms

Target Debt Ratio Variable Target is the initial debt ratio for investment-grade firms and for noninvestment-grade firms with an initial ratio below the industry 

average, and the industry average debt ratio for highly leveraged 

non-investment-grade firms

Rate of Movement Toward Target

Debt Ratio

Variable 10% for firms rated A or higher, 3% for firms rated BBB and nonrated 

firms, and 2% for non-investment-grade firms

Rate of Net Growth of Pension Plan 

Liabilities

0 

Markup for Pension Plan Liabilities (at 

default)

20% Termination liability is calculated by applying a 20% markup to current 

liabilities at the time of firm default

Fixed-Rate Premium $19

Variable-Rate Premium per $1,000 of 

Underfunding

$9

Criterion for Funding Waiver 72% IRS funding waiver is granted when firm assets are less than or equal 

to 72% of firm liabilities

Criterion for Firm Bankruptcy 70% Firm bankruptcy occurs when firm assets are less than or equal to 70% 

of firm liabilities

Criterion for Required Deficit Reduction 

Contribution (DRC) Payments

85% DRC payments are required when pension assets are less than 85% of 

pension liabilities

Criterion for Variable-Rate Premium 

Payments

90% Variable-rate premiums are required when pension assets are less 

than 90% of pension liabilities

Criterion for Voluntary Termination 200% Firms terminate their pension plans when assets are at least twice as 

large as pension liabilities
22 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Initial Data

CBO’s options-pricing model relies on publicly available 

information from a variety of sources for model inputs, 

and CBO generates some initial values using supplementary models as described below (see Tables C-1 and C-2 

for the inputs and assumptions, along with their sources).

B The initial market value of a firm’s assets is estimated 

from market equity, the book value of liabilities, and a 

model that derives the market value of debt from 

those inputs.

B The initial book value of a firm’s liabilities is derived 

from the firm’s 10-K filings with the Securities and 

Exchange Commission (SEC). Liabilities equal the 

sum of short- and long-term debt, plus pension plan 

underfunding, as reported on a firm’s balance sheet.4

B Pension assets are valued initially using reported values 

from corporate filings.

B The initial value of pension liabilities is estimated using the accumulated benefit obligation (ABO) value 

derived from a firm’s balance sheet (see Appendix B).

The initial market value of a firm’s assets must be estimated because it cannot be observed directly or derived 

from book values. By definition, the market value of a 

firm’s assets equals the sum of the market value of stockholders’ equity and the market value of the firm’s debt 

liabilities. The market value of a firm’s equity is readily 

available for the publicly traded companies that account 

for the vast majority of PBGC’s coverage. The book value 

of debt, which is recorded on a firm’s balance sheet, also is 

readily obtainable from SEC filings. The market value of 

debt, however, is generally not available and must be estimated. 

For debt, one important reason that book and market values often diverge is the possibility of bankruptcy, because 

in that case investors do not expect to receive the entire 

promised (book) amount on debt securities. The greater 

the probability of financial distress, the lower the market 

value relative to book value. 

The potential difference between book and market values 

can be large for the distressed firms that represent the 

largest risk to PBGC, and upward-biased estimates of 

firms’ liabilities would result from using book value as a 

proxy for market value.5 To adjust for the difference between the book value and market value of a firm’s debt, 

CBO employs the insights of Robert Merton, who demonstrates how to use available information on stock returns and industry asset-price volatility to estimate the 

market value of a firm’s liabilities.6 He notes that equity is 

like a call option on the assets of a firm, with a strike price 

equal to the face value of debt. Hence, given the market 

value of the equity, the volatility of that value, and the 

face value and maturity of the debt, options-pricing formulas can be used to infer the market value and volatility 

of a firm’s assets. 

The Simulation Model

The analysis proceeds by projecting the distribution of 

four interrelated variables over time: the market value of a 

firm’s assets, the book value of its liabilities, the market 

value of its pension fund assets, and the market value of 

its pension fund liabilities. Bankruptcy is triggered when 

the market value of a firm’s assets falls sufficiently below 

the book value of its liabilities. If a pension plan is underfunded when the sponsor’s bankruptcy occurs, the underfunding is a cost to PBGC. 

Market Value of a Firm’s Assets

A firm’s assets tend to grow over time, but year-to-year 

changes are volatile and reflect overall market conditions, 

variations in product demand, management decisions, 

and other unanticipated events. In the model, the projected path of asset values for each firm is based on the 

current market value of assets, historical average asset returns, and estimated asset volatilities.7

 Specifically, assets 

grow on average at their expected rate of return to inves4. For a few companies, underfunding of pension plans adds considerably to their obligations, but for most firms with underfunded 

pensions, the obligation is small relative to debt outstanding.

5. Changes in market interest rates also can drive a wedge between 

the book and market values of debt, especially for long-term securities. That factor is probably less important, however, in the relatively stable interest rate environment in recent years.

6. Robert C. Merton, “On the Pricing of Corporate Debt: The Risk 

Structure of Interest Rates,” Journal of Finance, vol. 29, no. 2 

(1974), pp. 449-470; and Robert C. Merton, “An Analytic Derivation of the Cost of Deposit Insurance and Loan Guarantees: An 

Application of Modern Option Pricing Theory,” Journal of Banking and Finance, vol. 1, no. 1 (June 1977), pp. 3-11.

7. The capital asset pricing model (CAPM) is used in conjunction 

with industry “betas” to estimate expected returns. Volatility estimates are derived from a model based on Merton (1977) and 

bounded above and below to reduce approximation error.
APPENDIX C THE CONGRESSIONAL BUDGET OFFICE’S PRICING MODEL FOR THE PENSION BENEFIT GUARANTY CORPORATION 23

tors, net of a constant dividend payout rate (equal to the 

initial payout rate for each firm). Interest payments, 

which ultimately must also be financed out of earnings, 

are accounted for by increasing a firm’s liabilities at the 

promised rate of interest. Those assumptions imply that, 

on average, the growth of a firm’s assets net of its liabilities equals the total after-tax return on assets minus dividends and interest payments, and that there are no equity 

issues or repurchases.

Book Value of a Firm’s Liabilities

A firm’s liabilities vary over time as new obligations are 

incurred and old debts are repaid. Liabilities grow each 

year at an interest rate that broadly reflects credit risk. 

Firms rated A and above accrue interest at the risk-free 

rate, firms rated BBB and firms that are not rated accrue 

interest at the risk-free rate plus a spread of 1.5 percent, 

and firms rated below BBB accrue interest at the risk-free 

rate plus a spread of 2.1 percent. 

CBO assumes that firms face limits on their leverage, or 

the proportion of their assets they can finance through 

borrowing, and that they tend to gradually adjust liabilities over time in the direction of a target ratio to assets. In 

practice, targets seem to vary widely among industries 

and even among firms within industries. The target ratio 

for investment-grade and nonrated firms is assumed to be 

the initial ratio of debt to assets. For below-investmentgrade firms, the target is set halfway between the initial 

ratio and the industry average when the firm is more 

highly leveraged than the industry average. The rate of 

convergence to the target is a choice variable that can be 

used for sensitivity analysis. For most of the analysis, 

however, the rate of convergence is set to 10 percent per 

year for firms rated A and above, 3 percent per year for 

firms rated BBB or firms that are not rated, and 2 percent 

per year for firms rated below BBB.8 For the financially 

distressed firms that pose the greatest risk to PBGC, increasing leverage further is difficult because new lenders 

are reluctant to assume the high level of risk, and restrictive covenants from old lenders may preclude the issue of 

additional debt. However, if distressed firms do manage 

to avoid insolvency, their liability-to-asset ratio will tend 

to shrink toward a normal level over time as asset values 

recover. 

Calibration to Bankruptcy Data

Transfer of net pension liabilities to PBGC occurs when a 

firm is bankrupt. In the model, the probability of bankruptcy depends on assumptions about a firm’s asset volatility, the evolution of the firm’s liabilities, and the trigger 

point for bankruptcy. To ensure that the probability of 

bankruptcy is consistent with experience, the model is 

calibrated to generate default rates close to the historical 

five- and 10-year default probabilities reported by Standard & Poor’s for each broad credit-rating category. Default probabilities are sensitive to many of the model’s assumptions, including asset volatility, the interest rate on 

debt, the dividend yield, and the rate at which liabilities 

move toward the target liability-to-asset ratio. The assumed interest rate spreads and liability adjustment rates 

are adjusted to obtain default probabilities in line with 

historical values. 

Market Value of Pension Assets

The future value of pension assets is uncertain because of 

variations over time in the rate of return on risky investments. In addition, pension assets are affected by the rate 

of a firm’s contributions and the rate at which funds are 

drawn down to pay beneficiaries. 

Typical plans invest in a mix of common stocks (both domestic and foreign), corporate and government bonds, 

and real estate, with 60 percent to 70 percent of funds in 

common stocks. Firms have some discretion in the types 

of investments that fund their pension plans, and although there is some variation among firms, in the base 

case, all investment portfolios have a common risk/return 

profile. 

The distribution of pension asset returns is based on the 

assumption that 70 percent of assets are held in stocks 

and 30 percent in bonds. The expected return on pension 

assets is based on the capital asset pricing model, with a 

stock market beta of 1 and a bond market beta of 0.1. 

The expected stock market return and standard deviation 

are taken to be 7 percent and 18 percent, respectively, and 

stock holdings are taken to be fully diversified so their 

risk is entirely market risk. The risk-free rate is fixed at 

3.5 percent. Those assumptions result in an expected return on pension assets of 6.1 percent and a standard devi8. George G. Pennachi and Christopher M. Lewis, “The Value of 

Pension Benefit Guaranty Corporation Insurance,”Journal of 

Money, Credit, and Banking, vol. 26, no. 3 (August 1994, Part 2), 

pp. 735-753. Pennachi and Lewis add a stochastic component to 

the value of liabilities to capture volatility caused by factors such as 

interest rate changes. For simplicity, and because the volatility of 

liabilities is relatively low, liabilities are assumed to be deterministic. That assumption reduces the estimated cost of insurance relative to Pennachi and Lewis’s estimates. 
24 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

ation of 13.1 percent. The estimate of pension asset volatility is conservative because of the assumptions that the 

stock portfolio is fully diversified and that there is no idiosyncratic risk associated with the bonds or other asset 

classes.

Stock returns are positively correlated with a firm’s asset 

returns because both are affected by common market influences and, to a lesser extent, because firms hold some 

of their own stock in pension asset accounts. 

Contributions

The Internal Revenue Code and the Employee Retirement Income Security Act impose minimum funding requirements for defined-benefit pension plans. Under the 

minimum funding rules, sponsors must invest an amount 

equal to the plans’ normal cost (in other words, any 

growth in estimated liabilities) each year. In addition, required contributions depend on the degree to which the 

plan is underfunded. Special funding rules, referred to as 

deficit reduction contribution (DRC) rules, require additional contributions from sponsors of underfunded plans, 

which are generally defined as plans with a ratio of assets 

to liabilities below 90 percent. Because pension liabilities 

are held fixed in the base case, there are no normal costs 

(except in some of the sensitivity analysis), and DRC payments are the only external source of funds. 

A plan is subject to the DRC when its ratio falls below 90 

percent, with special rules for plans with a ratio between 

80 percent and 90 percent. The model approximates the 

80 percent to 90 percent case by assuming that DRC payments are required whenever the ratio of assets to liabilities falls below 85 percent. The required DRC increases 

with the size of the funding gap. Those rules are represented in the model by assuming that for firms with a ratio of pension assets to liabilities below 60 percent, a contribution equal to 30 percent of the deficit is required 

each year. The DRC declines linearly to a contribution 

equal to 18 percent of the deficit as funding levels increase. Normal cost contributions are assumed to continue even when the 90 percent minimum is reached, because most firms voluntarily contribute until they are 100 

percent funded on an ABO basis to avoid requirements 

by the Financial Accounting Standards Board to report a 

minimum liability in their financial statements. The fact 

that many firms stop making DRC payments in the 

months leading up to bankruptcy is adjusted for through 

a cost-inflation factor that is discussed below in the section on termination liabilities. 

Market Value of Pension Liabilities

Estimating pension fund liabilities requires detailed information about the age and demographic structure of the 

covered workforce, expected job tenure with the firm, the 

formulas that determine pension and survivorship benefits, estimates of life expectancies and wage growth, and a 

model to use that information to generate the present 

value of liabilities. Lacking such information, this analysis 

uses the value of ABO liabilities reported in the 10-K filings of sponsors as a proxy for current liabilities (see 

Appendix B). 

Projecting a firm’s pension liabilities going forward 

through time would require similarly detailed information about the composition of a firm’s workforce and demographic trends. CBO makes the simplifying assumption in the base case that liabilities do not grow. A fixed 

level of liabilities would be observed for a firm with a balance between workers and retirees, such that the increasing present value of vested benefits for workers as they 

near retirement just offsets the falling present value of 

benefits for retirees as they age. For most firms, growth in 

liabilities is matched by normal contributions to pension 

assets. Hence, the fact that the cost of insurance depends 

on the gap between assets and liabilities rather than 

their levels mitigates the effect of the assumption of zeroliability growth. 

PBGC’s coverage is capped for high-wage beneficiaries. 

Information is not readily available to differentiate at the 

firm level between total reported pension liabilities and liabilities insured by PBGC. Thus, the estimated costs are 

biased up to the extent that some uninsured liabilities are 

identified as insured in the model. However, the percentage of benefits affected by that provision is small.

Termination Liabilities

Bankrupt firms with underfunded pension plans have 

historically imposed larger costs on PBGC than the level 

of underfunding they reported immediately prior to 

bankruptcy. That is, termination liabilities usually exceed 

current liabilities. Cessation of pension contributions in 

the period leading up to bankruptcy explains some of the 

difference. 

To reflect that experience, CBO assumes that estimated 

pension liabilities, as measured by the ABO, increase by
APPENDIX C THE CONGRESSIONAL BUDGET OFFICE’S PRICING MODEL FOR THE PENSION BENEFIT GUARANTY CORPORATION 25

20 percent at bankruptcy.9 Further, the possibility of reduced deficit reduction contributions when firms experience severe financial distress is reflected in the assumption that those payments cease when the ratio of a firm’s 

assets to its liabilities falls to 72 percent (2 percentage 

points above the level at which bankruptcy occurs). 

One offsetting factor is that PBGC has some claim to the 

unsecured assets of bankrupt firms. Historically, recovery 

rates by PBGC are low, however, and have declined in recent years. Consistent with recent experience, the recovery rate is assumed to be 7 percent of the unfunded liability. 

Terminations of Plans

Terminations of pension plans generally occur when a 

firm goes bankrupt. Companies declare bankruptcy when 

the value of their assets falls sufficiently below the book 

value of their liabilities. Consistent with previous studies, 

CBO set the bankruptcy trigger at a 70 percent ratio of a 

firm’s assets to its liabilities.10

Firms occasionally terminate plans voluntarily when it is 

financially advantageous to do so. Regulations preclude 

firms from withdrawing any excess balances from overfunded pensions to use for other purposes. They can, 

however, access those assets if they voluntarily terminate 

their pension plans. Such terminations are uncommon, 

and firms that terminate plans must pay a tax penalty on 

the excess balances. When voluntary terminations do occur, they reduce premium payments to PBGC and lower 

the average quality of the remaining covered firms. In the 

model, if pension assets rise to twice the level of pension 

liabilities, a condition that rarely occurs, it triggers a voluntary termination.

The number of covered participants changes over time. 

Some sponsors choose to terminate plans and switch to 

some other form of compensation for their employees, 

thus reducing the participant base. At the same time, new 

sponsors enter the system. Because it is hard to predict 

the net effect of those changes, CBO follows only the 

current population of participants. The participant base 

declines over the estimation period because of insolvencies or voluntary terminations resulting from significant 

overfunding.

Premium Payments

Current law requires firms to pay a base premium of $19 

annually per participant, plus an additional annual charge 

of $9 per $1,000 of underfunding. The charges are currently uncapped.11 Premiums are assumed to be paid in 

full except in the event of a firm’s bankruptcy or voluntary termination of its pension plan.

Estimated Net Costs

CBO’s model assigns a cost to PBGC when a firm enters 

bankruptcy and simultaneously has an underfunded pension on a termination basis. The cost is the present-value 

difference between the termination liability and the market value of pension assets at the time of the firm’s default. The model also estimates the present value of premium payments collected up to the point of default. The 

cost and premium for each firm are then netted together 

and summed across all firms to determine the expected 

9. Pennachi and Lewis, “The Value of Pension Benefit Guaranty net cost to PBGC. 

Corporation Insurance,” makes the same assumption.

10. Although a firm could declare bankruptcy at a higher asset-toliability ratio, most choose to continue operations with the hope 

of recovering.

11. Between January 1988 and June 1996, there was an upper limit 

on the variable-rate premium of between $34 and $53 per participant. 

Appendix D: Reconciling CBO’s Estimates of Underfunding with Those of the Pension Benefit Guaranty Corporation

D

Reconciling CBO’s Estimates of Underfunding with 

Those of the Pension Benefit Guaranty Corporation

The Congressional Budget Office’s (CBO’s) data set 

includes pension details for 1,179 publicly traded companies included in Compustat, Standard & Poor’s company 

reporting service database, as of November 2004. The reporting period for 1,114 companies is fiscal year-end 

2003, with the remaining companies reporting data for 

fiscal year-end 2004. All information entered in CBO’s 

model is publicly available from 10-K filings with the Securities and Exchange Commission. Pension asset values 

are generally marked to market, whereas pension liabilities represent obligations incurred as of the financial reporting date. In contrast, the Pension Benefit Guaranty 

Corporation (PBGC) relies largely on confidential filings 

of pension plans’ market value of assets and termination 

liability, required under section 4010 of the Employee 

Retirement Income Security Act for companies with 

more than $50 million in unfunded pension liabilities. 

When reporting underfunding for fiscal year 2004, 

PBGC primarily incorporates reported numbers from the 

4010 filings made by December 31, 2003.

Although CBO’s and PBGC’s databases differ substantially in many respects, their summary data for the extrapolated universe of defined-benefit pension plans are 

not very different. For example, total plan liabilities in 

CBO’s data set are $1,365 billion, while PBGC reports 

$1,553 billion.1 To approximate the universe of total 

plans insured by PBGC, CBO applied a scaling factor of 

1.14 ($1,553/$1,365) to its final estimates. 

PBGC reports $354 billion of underfunding on a termination basis for 2004 based on the 4010 filings, whereas 

CBO reports underfunding of $378 billion for its sample 

of publicly traded companies. Presumably, most firms required to file under section 4010 will be the publicly 

traded companies within CBO’s sample. Similarly, PBGC 

estimates total plan underfunding for 2004 in excess of 

$450 billion on a termination basis, whereas CBO’s 

scaled estimate is $431 billion.2

CBO’s measure of the total accumulated benefit obligation is $1,365 billion, and the total termination liability 

is $1,638 billion, which is simply the grossed-up accumulated benefit obligation (see Table D-1). However, when 

CBO reports those data for underfunded plans, the difference between the current liability and termination liability is more than 20 percent larger than the accumulated benefit obligation. The reason for that difference 

is that more plans are underfunded on a terminationliability basis than on a current-liability or ABO basis. 

The value of pension assets reported on a terminationliability basis compared with a current-liability basis is 

similarly larger, again reflecting the additional plans classified as underfunded on a termination basis.

APPENDIX

1. Pension Benefit Guaranty Corporation, Pension Insurance Data 

Book (2004), Table S-42, p. 67. Reported plan liabilities are as of 

the beginning of 2002.

2. Statement of Bradley D. Belt, Executive Director, Pension Benefit 

Guaranty Corporation, before the Senate Finance Committee, 

June 7, 2005. 
28 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Table D-1.

CBO’s Measures of Pension Liabilities, 

2003

(Billions of dollars)

Source: Congressional Budget Office.

Note: n.a. = not applicable.

a. Total liabilities of all defined-benefit plans are estimated by 

PBGC to be $1,553 billion as of January 1, 2003, implying a 

sample to universe scaling factor of 1.14.

All Plans

Underfunded 

Plans

Underfunding on a Current-Liability Basis

Current Liability 1,365 990

Pension Assets 1,269 841

Underfunding n.a. 148

Underfunding, scaleda n.a. 169

Underfunding on a Termination-Liability Basis

Termination Liability 1,638 1,523

Pension Assets 1,269 1,144

Underfunding n.a. 378

Underfunding, scaleda n.a. 431
E

Appendix E: Sensitivity Analysis

Sensitivity Analysis

This appendix reports the sensitivity of the cost estimates to several of the model’s assumptions, including 

the volatility of a firm’s assets, the trigger point for bankruptcy, the evolution of a firm’s debt levels, the risk-free 

rate, the growth rate of a firm’s liabilities, and a sponsor’s 

risk. It also illustrates how taking into account the price 

of market risk affects the Congressional Budget Office’s 

(CBO’s) estimates. 

The volatility of a firm’s assets is a critical determinant of 

the probability of a firm’s insolvency—and hence of the 

Pension Benefit Guaranty Corporation’s (PBGC’s) losses. 

A firm’s asset volatility is not directly observable and must 

be estimated. The firm’s stock price and volatility, together with information on liabilities, is used in an 

options-pricing model to infer the value and volatility of 

the firm’s assets (see Appendix C). The base-case volatilities generate default probabilities consistent with historical data for broad rating categories. To assess the sensitivity of CBO’s estimates to asset volatility, net costs are 

recalculated setting volatility equal to 80 percent and 120 

percent of the base-case estimate for each firm. The result 

is a range of net forward-looking costs for 10 years ranging from $32.9 billion at 80 percent volatility to $98.6 

billion at 120 percent volatility. 

The evolution of a firm’s liabilities also affects the probability of bankruptcy. In the base case, firms are assumed 

to gradually adjust debt levels to a target ratio, with faster 

adjustment for more highly rated firms (see Appendix C). 

In the alternative case considered here, firms do not adjust liabilities, which grow steadily with accumulated interest owed. The alternative raises estimated net costs by 

$22.7 billion. The increase occurs in this case because—

unlike the base case, in which firms that experience low 

returns reduce their debt—there is no debt adjustment. 

The estimates also are potentially sensitive to the assumed 

ratio of liabilities to assets that triggers bankruptcy, since 

a lower trigger decreases the probability of default. In 

practice, managers have considerable discretion in when 

to seek protection from creditors through bankruptcy, 

and debt ratios at the time of bankruptcy vary widely. In 

the base case, CBO follows the common practice of assuming that default occurs when assets fall below 70 percent of book liabilities. Increasing the trigger to 75 percent of book liabilities boosts estimated 10-year costs by 

$17.3 billion. 

The probability of a sponsor’s default, and hence of costs 

transferred to PBGC, varies systematically with the volatility of assets and the leverage ratio. Although those two 

factors interact, here their effects are considered separately. Specifically, the model is used to calculate the increase in premiums necessary to equate the cost per dollar 

of insured benefits for all risk groups. In each case, the 

cost to PBGC is set to that of the lowest-risk group. Because even those low-risk groups pay less than a fair premium rate now, greater rate increases would be necessary 

to balance premiums and costs. The results reveal that the 

riskier firms with underfunded plans are heavily subsidized under the current premium structure.

For its analysis, CBO divided firms into three similarly 

sized groups by asset volatility (see the top panel of 

Table E-1).1

 The premium increment reported is relative 

to firms with asset volatility of less than 13 percent, the 

lowest-risk group. The premium is set so that the net cost 

per dollar of pension liabilities is equalized among the 

APPENDIX

1. CBO’s model generates asset-volatility estimates for individual 

firms, which are used in those estimates. In general, a firm’s asset 

volatilities are not directly observable, but industry classifications 

could be used as proxies. 
30 THE RISK EXPOSURE OF THE PENSION BENEFIT GUARANTY CORPORATION

Table E-1.

Premium Multiples to Equalize Costs 

Across Risk Groups

Source: Congressional Budget Office.

Note: Firms with assets in different volatility classes or with different ratios of liabilities to assets present different risks of 

bankruptcy and hence of plan termination. This table reports 

by what factor premiums (both fixed and variable) would 

have to be multiplied in order to equalize PBGC’s expected 

costs for each risk group with that of the lowest risk group.

three groups. The large effect of asset volatility on the 

probability of bankruptcy explains the large increase in 

premiums required to bring the cost of high-risk firms in 

line with that of low-risk firms.

A lower liability-to-asset ratio reduces the risk of bankruptcy and hence reduces expected costs. As with volatility, the firms are divided into three approximately equally 

sized groups. The premium increment reported (see the 

bottom panel in Table E-1) is relative to the firms that 

have a leverage ratio below 39 percent. The premium for 

firms in the other two groups is increased so that the net 

cost per dollar of pension liabilities is equalized.

The market risk inherent in PBGC’s guarantees is a significant component of cost in all of CBO’s estimates. 

That is because the guarantee is more likely to be called 

upon when overall economic conditions are depressed 

and the resources expended most valuable. As discussed 

earlier, the correlation between an economic downturn 

and an increase in PBGC’s net liabilities arises for two 

main reasons: the value of plan assets, which are composed largely of stocks, tends to fall in downturns, leaving 

plans underfunded; and the probability of bankruptcy increases when the economy is weak, increasing the likelihood that underfunded plans will have to be assumed by 

PBGC.2

To measure the effect of market risk, the forward-looking 

net cost of $63.4 billion can also be compared with an estimate that excludes the cost of market risk by discounting projected cash flows at a Treasury rate. Using a Treasury rate, PBGC’s net cost is estimated to be about half of 

its fair market value. However, the result is highly sensitive to the assumed equity premium. Market risk thus accounts for a substantial share of the cost of PBGC insurance. That is probably a more important factor for 

pensions than for many other federal credit and insurance 

programs because there are two compounding sources of 

market risk: bankruptcies by plan sponsors tend to increase during bad economic times and, simultaneously, 

underfunding of pension plans tends to increase both because the value of plans’ assets falls when the stock market 

is down, and the value of liabilities increases with lower 

interest rates. 

Risk Factor Multiple of Current Premium

Firm Asset Volatility

Less than 0.13 1.0

0.13 to 0.21 2.0

More than 0.21 10.6

Liability-to-Asset Ratio

Less than 0.39 1.0

0.39 to 0.66 2.7

More than 0.66 10.1

2. PBGC’s Pension Insurance Modeling System also includes a link 

between economic downturns and PBGC’s costs.

INSIDE MAIL

CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

WASHINGTON, DC 20515