Corporate Pension Policy and the Value of PBGC Insurance

Marcus, Alan J.

doi:10.3386/w1217

Cited by 40 publications

(57 citation statements)

References 11 publications

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“…Marcus (1987) essentially considers the PBGC's liability as that of a long position in a forward contract on the pension fund assets, with an exercise price equal to fund liabilities and a stochastic maturity date. In that exercise, the PBGC still obtains the surplus in an overfunded plan.…”

Section: Implementation and Discussionmentioning

confidence: 99%

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Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

Binsbergen¹,

Novy-Marx

Rauh

2014

Tax Policy and the Economy

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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. Keywords: Pension insurance, Pension Benefit Guaranty Corporation, pension liabilities, liability valuation, option pricing of government liabilities. Executive SummaryIn 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 riskneutral 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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Section: Implementation and Discussionmentioning

confidence: 99%

“…Following this recognition, there have been several empirical attempts to use options pricing models to price these guarantees on a plan-by-plan basis (Marcus 1987;Pennachi and Lewis 1994;Kiska, Lucas, and Phaup 2005).…”

Section: Financial Valuation Of Pbgc Insurance With Market-implied Dementioning

confidence: 99%

Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

Binsbergen¹,

Novy-Marx

Rauh

2014

Tax Policy and the Economy

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“…The passing of the Employee Retirement and Income Security Act (ERISA) of 1974 began the process of imposition of stricter legal, funding, and solvency requirements in the United States, including establishment of the Pension Benefit Guaranty Corporation (Marcus 1987). Similar requirements in Canada were put in place by the Pension Benefit Acts.…”

Section: New Tax Laws and Funding Regulations Have Decreased The Attrmentioning

confidence: 99%

Macroeconomic Aspects of Private Retirement Programs

Ostaszewski

2001

North American Actuarial Journal

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The decline in importance of private defined benefit plans in relation to defined contribution plans in the United States is a major issue of interest to pension actuaries. This decline has been attributed to numerous factors: costs of government regulation, societal and cultural changes, changed employer attitudes, and employees' lack of understanding of defined benefit plans. It has also caused some observers to proclaim the end of private defined benefit plans. This paper analyzes possible macroeconomic factors contributing to the crisis of defined benefit plans and proposes an alternative hypothesis for the cause of the crisis: the decline of the relative attractiveness of defined benefit plans in relation to defined contribution plans when these are viewed as investments, that is, as securities in capital markets.

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“…The cost of pension guarantees have been analyzed in papers by Pesando (1982), Marcus (1985Marcus ( , 1987, Bodie and Merton (1993), and, most recently, Bodie (2001). 4 Smetters (2001) focuses on recent privatization plans, including the Feldstein-Samwick (1997) plan and the Gramm (1998) plan.…”

Section: Public Pension Conversions Throughout the Worldmentioning

confidence: 99%

Controlling the Cost of Minimum Benefit Guarantees in Public Pension Conversions

Smetters¹

2002

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Unfunded defined-benefit (DB) public pension plans throughout the world are being converted to funded defined-contribution (DC) plans that typically contain a minimum benefit guarantee (DC-MB). Risk management techniques must be used to control the cost of these guarantees. The most common technique is to "over-fund" the benefit: the contribution rate is set high enough so that the expected benefit is much larger than the guaranteed minimum benefit. This paper shows that while over-funding is very effective in controlling guarantee costs in traditional DB plans, it is highly ineffective for DC-MB plans. This result holds even at very large contribution rates and when risky investments are restricted to a very diversified index like the S&P500. Calculations show that the true risk-adjusted value of unfunded guarantees in a realistic DC-MB plan equals 40 to 90 percent (or more) of the value of the unfunded liability in the DB benefit being replaced, depending on design. This result is true even when the contribution rate in the DC-MB plan is chosen to produce an expected benefit five times larger than the DB benefit. This paper considers two approaches to controlling guarantee costs. The first approach borrows from the recent catastrophic insurance literature. A "standardized" portfolio is guaranteed, requiring agents to accept "basis risk" if they chose a non-standard portfolio. However, for large conversions from DB to DC-MB plans, in which there is little or no DB benefit remaining, the government must still worry about any "implicit guarantee" extending beyond the standardized portfolio, thereby enticing agents to accept a lot of basis risk (a "Samaritan's Dilemma"). The second method, therefore, uses a more brute force approach: private portfolio returns in the good states of the world are taxed while returns in the bad states are subsidized. Both options are very effective at controlling guarantee costs, and they can be used separately or together. Calculations demonstrate that all of the unfunded liabilities associated with modern pay-as-you-go public pension programs can be eliminated under both approaches even at a modest contribution rate.

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Corporate Pension Policy and the Value of PBGC Insurance

Cited by 40 publications

References 11 publications

Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

Macroeconomic Aspects of Private Retirement Programs

Controlling the Cost of Minimum Benefit Guarantees in Public Pension Conversions

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