Finance Papers

Document Type

Journal Article

Date of this Version

2014

Publication Source

Tax Policy and the Economy

Volume

28

Issue

1

Start Page

133

Last Page

154

DOI

10.1086/675590

Abstract

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.

Copyright/Permission Statement

© 2014 by The University of Chicago Press

Comments

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.

Keywords

Pension insurance; Pension Benefit Guaranty Corporation; pension liabilities; liability valuation; option pricing of government liabilities

Embargo Date

2015

Share

COinS
 

Date Posted: 27 November 2017

This document has been peer reviewed.