Pension Funds and Bankruptcy
Most pension funds around the world are funded by employers. Hence, if people work in the private sector, they have a private pension plan. Similarly, if they work in the public sector, they have a pension plan which is sponsored by the government.
Employees enrolled in both these types of plans run the risk that their employer might go bankrupt and that their pension payments might be jeopardized.
It is true that employees working in the private sector are more prone to this risk. However, it does not mean that the ones working in the public sector are immune to it.
In this article, we will have a closer look at what happens if the employer sponsoring the pension fund goes bankrupt. The situation will be different for the public sector and private sector employees. The details have been mentioned below:
What Happens If a Private Sector Employer Goes Bankrupt?
Pension funds are designed in such a way that the employer is supposed to make contributions to the plan at periodic intervals. However, a lot of the time, employers face cash flow issues and are not able to make these contributions.
It is also possible that the employer did make the contributions in a timely manner. However, due to the fall in the value of the investments, the fund has a shortfall. In either case, it is possible that the pension liabilities may be greater than the pension-related assets of the firm.
In many cases, it is possible that the pension liabilities also exceed the total assets of the firm. In such cases, it is impossible for the firm to pay off its liabilities. In such cases, the proceedings will eventually reach bankruptcy court and it is likely that the court may declare the company bankrupt.
What Happens If an Employer Goes Bankrupt?
The financial future of thousands of employees can be linked to that of an employer. Hence, bankruptcy can ruin the retirement of thousands of people. In order to prevent this, government organizations have been created which guarantee the pension funds of employees.
For instance, in the United States, the Pension Funds Guarantee Corporation (PBGC) is a federal body that has been created to support employees in case their employers go bankrupt.
When it comes to government employees, their employer is either the municipal, state, or federal government. It is possible for state or municipal governments to routinely go bankrupt. In such cases, the federal government i.e. the taxpayer will end up covering the shortfall. However, it is very rare for the federal government to go bankrupt. This is because not only do they have the power to tax people but they also have the power to print money. Hence, the likelihood of bankruptcy goes down significantly.
How Are Guarantee Corporations Funded?
Pension guarantee corporations are federal bodies in most parts of the world. Hence, it is assumed that these bodies are funded by taxpayer money. However, this is not true! In most cases, these bodies function in a manner that is financially independent. This means that they do not receive taxpayer dollars.
Instead, they work as an insurance company. This means that individual pension funds provide a periodic premium payment to such bodies. These premium payments are then pooled together to create a fund.
The pension payments of the employees of bankrupt companies are then made from this fund. However, the guarantee bodies are not free to set their premium rates in most parts of the world. The setting up and periodic revision of these premium rates is done by government bodies.
Types of Guarantees Provided by the Guarantee Corporation
It is important to note that every pension fund which takes the protection of the guarantee scheme is not fully covered. It is possible for the pension fund to opt for partial coverage as well.
For instance, in the United States, the Pension Benefits Guarantee Corporation (PBGC) provides single employer as well as multi-employer plans.
The single-employer plans cover the entire range of benefits that are due to the employee. On the other hand, the multi-employer plans cover only a percentage of the overall benefits. In most cases, around 25% of the benefits are covered. Hence, it is possible for the pensioners to still be at risk of bankruptcy.
Can The Guarantee Corporation Itself Go Bankrupt?
Theoretically, the Pension Benefits Guarantee Corporation (PBGC) and other similar bodies work like an insurance company. Hence, just like an insurance company, if they face a lot of claims simultaneously, it can go bankrupt. This is because like insurance companies, the guarantee funds cannot reinsure their risks. It is possible that a recession may cause a large number of companies to face financial turmoil. This could lead to several simultaneous claims being made on the guarantee corporation.
The Pension Benefits Guarantee Corporation (PBGC) has already issued a warning that it might be on the verge of facing bankruptcy. Such an event has never happened in the financial history of the world. However, theoretically, the government would be bound to cover the shortfall in most cases.
It is important to note that even though theoretically the pension funds of employees could be lost in a bankruptcy, such an event has never happened to date even though the world has gone through several instances of financial turmoil. Hence, it can be assumed that pension payments are more or less guaranteed.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Why are Pension Funds Important?
- Different Asset Classes in which Pension Funds can Invest
- Why Managing Liquidity is Important for Pension Funds?
- Impact of Liquidity on Pension Funds
- Green Pensions
- Pension Funds as a Policy Tool Used by the Government
- Pension Funds and Fiduciary Duty
- Pension Funds and Taxation
- The Optimal Pension Fund Size
- Defined Benefit Pension Plans
- Pros and Cons of a Fixed Benefit Pension Plan
- Advantages of Defined Contribution Plans
- Disadvantages of Defined Contribution Pension Plans
- The Impact of Technology on Pension Funds
- Pros and Cons of Technology in Pension Funds
- Hybrid Pension Schemes
- How Do Pension Funds Influence Economic Growth?
- How do Demographic Changes Affect Pension Funds?
- Problems in Comparing Pension Fund Returns
- How a Recession Will Impact Pension Funds?
- Alternative Assets in Pension Funds
- Longevity Risk and Pension Funds
- Longevity Bonds and Longevity Derivatives
- Impact of Covid on Pension Funds
- Outsourcing and Pension Funds
- Pension Funds in Developing Economies
- Pension Funds and Wealth Inequality
- The Regulation of Pension Funds
- Types of Pension Fund Regulation
- Responsibilities of Pension Fund Regulators
- Pension Funds and Bankruptcy
- Pension Funds and Cryptocurrencies
- Pension Funds and Private Equity Investments
- Shortfall Risks and Pension Funds
- Pension Funds Vs. Mutual Funds
- Pension Funds and Real Estate
- Challenges Facing Pension Fund Governance
- Collective Pension Schemes
- Pension Funds and the Use of Derivatives
- Pension Funds and Infrastructure Sector
- Pension Funds and Systemic Risks
- Fundamental Principles of Pension Fund Risk Management
- Risk-Based Supervision of Pension Funds
- How Risk-Based Supervision System Works?
- Challenges of Risk-Based Supervision of Pension Funds
- The Chinese Pension System
- Challenges Faced by the Chinese Pension System
- Why Pension Funds Should Not be Allowed to Invest in Equity?
- Liability Driven Investing
- Pension Funds and Income Redistribution
- Gender Gap in Pension Systems
- Assumptions in Pension Fund Accounting
- Priority Creditor Rights for Pension Funds
- Pension Fund Governance Structure and its Need