Bankruptcy and Workers: Risks, Compensation and Pension Contracts

One can view workers from the perspective of the portfolios they hold. For most workers, this portfolio, broadly defined, evinces a heavy concentration of assets in the firm that employs them. They stand to incur wage reductions if they move to some other company midway in the contract because much of the human capital that they hold is not fully transferable. In many cases, they also stand to lose substantial pension value, and may lose other benefits as well, such as health insurance, longer vacation periods earned through seniority and so on. This just means that they are party to a risky venture, where the downside outcome poses substantial losses. It turns out that the broad implications of bankruptcy for workers are well indexed by pension losses, which means that an understanding of the pension implications of bankruptcy also conveys the thrust of non-pension losses as well. Risk is not a free good. As in standard models of finance, firms are expected to pay for the risks they impose on workers, and indeed, are expected to pay premia in excess of those implied in financial models if they expose workers to non-diversified risks. The latter premium makes sense only if firms believe that heavily exposed workers are more likely to work hard to ensure the continued viability of their employer. If this incentive is sufficiently strong then higher productivity finances the additional risk premia. Workers can choose jobs among employers that pose different levels of bankruptcy risks, and those least willing to undertake risk take jobs with relatively low levels of it, and receive commensurately lower pay., As such, there is no reason to believe that workers’ losses in some bankrupt companies raise special public policy concerns. Most workers at risk experience the upside potential; a small percentage experiences the downside. There is no reason to believe that the contracts ex ante are inefficient. But if the government may have to assume responsibility for near destitute older workers, then this prospect might give rise to various mandatory insurance schemes. Even if these insurances are not market priced, the participants at least have to pay some of the costs of the exposure they incur. This may be one reason why institutions like unemployment compensation and pension insurance arise. The compensating differential model used to explain the risk-reward tradeoff inherent in defined benefit pension plans also can explain their demise. Beginning in the mid 1980s, the federal government altered its traditional bonding role in the contract and, instead, permitted firms to unilaterally terminate defined benefit plans and take excess assets (those in excess of termination benefits) into corporate profits. This had the result of exogenously increasing the probability of termination far greater than bankruptcy risks. Workers were (justifiably) more leery of the pension promise, which reduced the amount that they were willing to pay for it. The plans, therefore, are valued by less than it cost the companies to provide them, which creates the incentive to move towards pension plans that are self-bonded, such as 401k plans. 401k plans have dominated pension growth for the past twenty years and are fast becoming the pension plan of choice in the (non-union) private sector. While they eliminate the bankruptcy risks inherent in defined benefit plans, they create their own set of bankruptcy exposures. While most workers covered by these plans do not invest in company stock, about one in ten have at least half their account balances concentrated in the securities issued by the firm that employs them. In many large companies, 401k plans are heavily invested in company stock. These investment patterns can give rise to the potential for catastrophic losses for workers late in their career. In order to protect themselves from ex post bailouts, taxpayers may want to give some thought to enforcing some set of minimum diversification rules in these plans

Risk-based supervision of pension institutions in Denmark

This paper examines the move towards risk-based supervision of pension institutions in Denmark. Although Denmark has not adopted a comprehensive model to assess risk it has developed a number of building blocks which it uses for risk-based assessment. The motivations for improving risk assessment include a desire to identify emerging problems, and concerns about the solvency of pension institutions. In Denmark there is extensive use of guaranteed minimum returns in both the accumulation and payout phases which create substantial obligations on pension institutions, and focus attention on the integrity and solvency of the institutions which provide them. In conjunction with freeing up investment restrictions and moving towards market valuation of assets, the supervisor has introduced a'traffic light'stress test model which calculates the effect of several market scenarios - the red test which is the more plausible and the yellow test which is possible but less likely. In addition to the use of the traffic light system, there has been a growing emphasis on the adequacy of internal risk control systems and greater reliance on market discipline. Pension institutions have sought to reduce their exposure to market volatility by better matching of assets and liabilities. There is a much better understanding of the risks inherent in the pension institutions'portfolios, and there has been a substantial increase in the use of hedging instruments.Debt Markets,,Emerging Markets,Insurance&Risk Mitigation,Banks&Banking Reform

Designing the payout phase of funded pension pillars in central and eastern European countries

Over the past decade or so, most Central and Eastern European countries have reformed their pension systems, significantly downsizing their public pillars and creating private pillars based on capitalization accounts. Early policy attention was focused on the accumulation phase but several countries are now reaching the stage where they need to address the design of the payout phase. This paper reviews the complex policy issues that will confront policymakers in this effort and summarizes recent plans and developments in four countries (Poland, Hungary, Estonia, and Lithuania). The paper concludes by highlighting a number of options that merit detailed consideration.Debt Markets,Pensions&Retirement Systems,Financial Literacy,Insurance&Risk Mitigation,Investment and Investment Climate

Financial Risks and the Pension Protection Fund: Can it Survive Them?

This paper discusses the financial risks faced by the UK Pension Protection Fund (PPF) and what, if anything, it can do about them. It draws lessons from the regulatory regimes under which other financial institutions, such as banks and insurance companies, operate and asks why pension funds are treated differently. It also reviews the experience with other government-sponsored insurance schemes, such as the US Pension Benefit Guaranty Corporation, upon which the PPF is modelled. We conclude that the PPF will live under the permanent risk of insolvency as a consequence of the moral hazard, adverse selection, and, especially, systemic risks that it faces.

America Needs a Raise

[Excerpt] America needs a raise, in the worst kind of way. While productivity, profits, executive pay and the stock market keep going up, working family incomes keep going down, widening the gap between the rich and the rest of us and creating a dangerous atmosphere of social and economic conflict. Workers are having to labor harder and longer just to keep even, and more and more family members are having to work in order to maintain living standards. Working families have little money to spend, they are loaded with debt and they have no time to spend with their children. Threatened by restructuring, downsizing, pension raids, privatization schemes and runaway plants, their anger is exceeded only by anxiety over keeping their jobs. They are disgusted with business and government and their disillusionment is straining the fabric of our society

German insurance industry: market overview and trends

This article presents an overview of the contemporary German insurance market, its structure, players, and development trends. First, brief information about the history of the insurance industry in Germany is provided. Second, the contemporary market is analyzed in terms of its legal and economic structure, with statistics on the number of companies, insurance density and penetration, the role of insurers in the capital markets, premiums split, and main market players and their market shares. Furthermore, the three biggest insurance lines—life, health, and property and casualty—are considered in more detail, such as product range, country specifics, and insurance and investment results. A section on regulation outlines its implementation in the insurance sector, offering information on the underlying legislative basis, supervisory body, technical procedures, expected developments, and sources of more detailed information

The payout phase of pension systems : a comparison of five countries

This paper provides a comparative summary of the payout phase of pension systems in five countries -- Australia, Chile, Denmark, Sweden, and Switzerland. All five countries have large pension systems with mandatory or quasi-mandatory retirement savings schemes. But they exhibit important differences in the structure and role of different pillars, regulation of payout options, level of annuitization, market structure, capital regulations, risk management, and use of risk sharing arrangements. The paper summarizes the experience of these countries and highlights the lessons they offer to other countries.Pensions&Retirement Systems,Debt Markets,Emerging Markets,Insurance&Risk Mitigation,Investment and Investment Climate

Financing Problems as a Pretext for a Change in the Spanish Social Security System Model: The Role of Financial Institutions and Their Media

This study summarizes the traditional characteristics of the Spanish Social Security System (generally taken from the European model), the different legal reforms that have come into force in recent years and the degree of penetration of important financial groups in the mass media which increased with the last financial crisis as well as the role developed by the insurance and financial entities benefiting from the change of model. The conclusion is that we are at the beginning of an interesting change in the Social Security model, aimed at the capitalization of social contributions by the private sector, which will obtain significant economic benefits in the management of old-age risk

Whose Job Is It, Anyway? Capital Strategies for Labor

[Excerpt] When corporate mergers and takeovers create massively debt-ridden new entities, with the resulting pressures to sell off assets, reduce costs (especially wages) and close marginal operations, it is the company\u27s workers and their communities who suffer. And, when corporate managers accept, and even encourage, huge levels of waste, or ignore obvious opportunities because they aren\u27t profitable enough, workers and their communities end up paying for the resulting inefficiencies and lost potential. I believe that a hallmark of the new economic era we seem to be entering will be that workers and unions will be forced to actively concern themselves with all aspects of an employer\u27s business — with the intricate details of corporate structure, finance, and operations. In the process, they will have to evolve a comprehensive approach to the process of production and distribution, to investment and financial issues, as well as to corporate organization and control. In short, they will need to begin learning how to organize economic resources themselves and evolve what have been called capital strategies