Date of this Version
This paper uses economic principles to analyze alternative definitions for end-of-period liabilities under post-employment benefit plans; the candidates, using U.S. nomenclature, are the vested benefit obligation (VBO), the accumulated benefit obligation (ABO) and the projected benefit obligation (PBO). In competitive employment markets with rational contracting we are unable to justify projected costing (PBO-based) for typical pay-related defined benefit plans. Projected costing misrepresents the economic obligations incurred by shareholders and invites moral hazard. Employee exposure to moral hazard may be minimized by exit costing (VBObased) which recognizes only those benefits to which an exiting employee is entitled under the explicit benefit contract. But exit costing may not fully inform shareholders about the obligations that they have incurred under implicit contracts that extend beyond the plan document. Accrued costing (represented in the U.S. by the ABO) may better measure shareholders’ economic commitments. Small differences between the ABO and the VBO may measure a human capital asset incented by delayed vesting and benefit eligibility. Large differences are a marker for frail benefit design and potential moral hazard. Moral hazard options exercised by employers disappoint employees and may lead to unwelcome ex-post results-oriented repairs imposed by legislators, regulators and courts.
Insurance, Pensions, Retirement and Retirement Policies, Social Security and Public Pensions
G22, G23, J26, J32, H55
Working Paper Number
Copyright by the Society of Actuaries, Schaumburg, Illinois. Reprinted with permission.
Date Posted: 30 August 2019