Essays on Defined Benefit Pension Plans in the USA

This thesis contains three fundamental and empirical essays with the aim of finding the optimum full funding limit policy for the defined benefit (DB) pension plan system in the USA in terms of Government tax earnings and pension claims. To achieve this aim, I study sponsor contributions and plan terminations in the first two essays and building on these I investigate the optimum policy limit in the third essay of the thesis.

In the first essay, I investigate the influence of enforcement of full funding limits on sponsor contributions to private DB pension plans in the US. The full funding limit is a limit on the maximum asset amount that restricts the tax advantages of making voluntary contributions to pension funds. This essay fills a research gap by using only voluntary contributions to analyse the impact of the full funding limit. The results show that, sponsors are less likely to make tax-deductible voluntary contributions when the plans’ funding ratio surpasses the full funding limitation. At the other hand, a lower than required pension plan funding ratio (pension assets/ pension liabilities) increases the likelihood of a voluntary contribution. These findings together support the idea that sponsors want to prefund the balance, but only until any tax advantages are maximized.

The second essay includes the full funding limit policy along with both firm and plan specific variables in studying termination decisions using a more comprehensive dataset than used in any previous study. The analysis shows that the condition of the firm only affects the termination decision for PBGC trusteed termination. The state of the plan affects both standard and PBGC trusteed terminations, but in differing ways. The tax rate affects the termination decisions, but in a manner that depends on the funding status of the plan and the type of termination.

The third essay determines the optimum value of the full funding limit percentage to ensure better funding positions for defined benefit pension plans and higher profit (i.e., tax earnings – PBGC claims) for the Government. Using estimates from the first two essays and actuarial assumptions for projecting the 757 existing firms for the next 50 years, I generate scenarios to calculate the profit of the Government using tax earnings and PBGC claims for different full funding limitation percentages. My results show that, although the range is larger than the current policy, a narrow range for the full funding limit (110% of pension liability over pension assets) yields the maximum profit. This limit generates the highest tax earnings and the lowest PBGC claims out of all the tested possibilities (which ranged from 100% to 200%). The effect of this limit on tax earnings is the major contributing factor behind this finding.