Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

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Finance Papers
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Pension insurance; Pension Benefit Guaranty Corporation; pension liabilities; liability valuation; option pricing of government liabilities
Finance and Financial Management
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Taxation
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Binsbergen, Jules H. van
Novy-Marx, Robert
Rauh, Joshua
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In this paper, we use financial valuation techniques to measure the unfunded liabilities associated with the Pension Benefit Guaranty Corporation (PBGC) single-employer pension insurance program. This is an alternative approach to the calculations of expected future PBGC payouts in the PBGC exposure reports. The PBGC insurance is akin to an exchange option, a financial instrument that allows a party to exchange one risky asset for another. Calculating the value of this option for each PBGC-covered plan provides a measure of the fair market price of the PBGC guarantee that is consistent with the finance principles of risk-neutral pricing. That is, the market valuation method reflects the fact that bad outcomes tend to coincide with times when losses are particularly painful. The valuation we perform also reflects the fact that PBGC insurance is triggered only in the case of bankruptcy by drawing on the default probabilities implied by the credit ratings of insured plans. Under the baseline parameters, the PBGC’s insurance of the unfunded liabilities has a financial value of $358 billion, net of the estimated present value of PBGC premiums.

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2014-01-01
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Tax Policy and the Economy
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At the time of publication, author Jules H. van Binsbergen was affiliated with Stanford University. Currently, he is a faculty member at the Finance Department of the Wharton School at the University of Pennsylvania.
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