Are Pension Funds too Important to Fail? Or too Big to Save?

To answer those questions the definitions of failing and saving should be clear. A pension fund fails because the balance between assets and liabilities is insufficient. Since there is already extensive literature on liabilities being higher than anticipated but not on assets being lower than expected, this paper focuses on the assets. The ultimate consequence of failing is that a pension fund has to reduce pension entitlements and rights. There are two types of failure. The first type is a single pension fund failing, this is called an idiosyncratic failure. The second type is multiple pension funds failing simultaneously and this can be considered as a systemic failure. Policies activated ex ante to a failure are to prevent failing of pension funds. However, when a pension fund is already failing, the employer or the government may intervene and save a pension fund. So these saving policies are activated ex post to a failure. The employer and the government together have four possible ways of saving a pension fund. The employer has only one option to rescue its pension fund, which is by means of an employer bailout. The government can bailout a pension fund as well but also has two other saving strategies in addition: temporary relaxing funding rules or establishing a pension guarantee fund.

This paper examines whether pension funds are too important to fail and, if so, what appropriate policy measures are. The pros and cons of the different policy strategies are analyzed. Alternatively, pension funds may also be too big to save. Literature on pension funds being too important to fail or too big to save is scarce. There is however extensive literature on these questions for banks. We analyze the available banking literature and evaluate to what extend it is applicable to pension funds. Furthermore we empirically analyze whether one of the moral hazards that characterizes a too important to fail environment, excessive risk taking, occurs in the Dutch pension fund sector. Finally policy recommendations will be given with respect to failing pension funds.

This paper concludes that pension funds may be too important to fail for society. This is however only the case with one type of failure, i.c. systemic failure. The reason is the significant risk a large systemic failure poses for social and economic unrest. In case of an idiosyncratic failure this risk is much lower. From the four mentioned saving vehicles, two are fit too important to fail policies; temporarily relaxing funding rules and a government bailout. These two are fit because they are useful in case of a systemic failure. The other two saving vehicles, employer bailout and pension guarantee fund, are only useful in case of an idiosyncratic failure. Since a pension fund is only too important to fail in case of systemic failure an employer bailout and a pension guarantee fund are not too important to fail policies. Both too important to fail policies, temporarily relaxing funding rules and a government bailout, increase the level of the intergenerational risk sharing characteristic of pension funds.